Item 1. Business
General
Lifecore Biomedical, Inc. (“Lifecore” or the “Company”) designs and markets dental implants and manufactures hyaluronan and medical devices based on hyaluronan for use in various surgical markets. The Company was incorporated in the State of Minnesota in 1965. The Company operates two divisions, the Hyaluronan Division and the Dental Division. Further information about Lifecore can be obtained from Lifecore’s internet website at www.lifecore.com. The contents of the website are not intended to be a part of this Form 10-K and are not incorporated by reference. Also, Lifecore makes available free of charge through its internet website the Company’s Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”), as soon as reasonably practicable after it electronically files such material with, or furnishes such material to, the Securities and Exchange Commission.
The Company’s Hyaluronan Division is principally involved in the development and manufacture of products utilizing hyaluronan, a naturally occurring polysaccharide that is widely distributed in the extracellar matrix of connective tissues in both animals and humans. In addition, the Company has licensed a sodium hyaluronate cross-linking technology from The Cleveland Clinic Foundation (“CCF”) designed to provide a development vehicle for a product platform to introduce new products for the existing medical segments, as well as potentially new market segments. Furthermore, we are pursuing other development activities to utilize the Company’s fermentation and aseptic filling capabilities for non-hyaluronan based products.
The Hyaluronan Division primarily sells into three medical segments: 1) Ophthalmic, 2) Orthopedic and 3) Veterinary. Lifecore also supplies hyaluronan to customers pursuing other medical applications, such as aesthetic surgery, medical device coatings, tissue engineering and pharmaceuticals. The Company leverages its hyaluronan manufacturing expertise to provide expanded hyaluronan product offerings and specialized aseptic manufacturing of hyaluronan products.
The Company’s Dental Division develops and markets precision surgical and prosthetic devices for the restoration of missing dentition. The Company’s dental implants are permanently implanted in the jaw for tooth replacement therapy as long-term support for crowns, bridges and dentures.
The Dental Division also offers innovative bone regenerative products for the repair of bone defects resulting from periodontal disease and tooth loss. Additionally, the Dental Division provides professional support services to its dental surgery clients through comprehensive education curricula, as provided in the Company’s various Skills Series and Know HOW courses. These professional continuing education programs are designed to train restorative clinicians and their auxiliary teams in the principles of tooth replacement therapy and practice management. The Company’s Increasing Case Acceptance (“ICA”) program offers clients the marketing and consultative tools and training to foster higher patient acceptance of dental implants.
The Dental Division’s products are marketed in the United States through the Company’s direct sales force. Internationally, the Dental Division’s products are marketed through direct subsidiaries in Italy, Germany, France and Sweden, and through 28 national distributors covering 49 additional countries.
Financial information by business segment and geographic area is contained in Note H to the Company’s Consolidated Financial Statements.
Trademarks
The following trademarks are the property of Lifecore: LUROCOAT® Ophthalmic Solution; ORTHOLURE™ Orthopedic Viscosupplement; PRIMA™, RENOVA®, RESTORE® and SUSTAIN® Dental Implant Systems; STAGE-1® Single Stage Implant System; Quick-Cap® Impression System; CALFORMA® Calcium Sulfate Barrier; CALMATRIX® Calcium Sulfate Binder; CAPSET® Calcium Sulfate Bone Graft Barrier; SlowSet™; TefGen® Regenerative Membrane; and Support Plus®. U.S. trademark registrations are generally for a term of 10 years, renewable every 10 years as long as the trademark is used in the regular course of trade.
Viscoat® Intraocular Viscoelastic is a registered trademark of Alcon, Inc. (“Alcon”); Vitrax®II Ophthalmic Viscosurgical Device is a registered trademark of Advanced Medical Optics; Hyaluron HEXAL® is a registered trademark of Novartis AG; HY-50® is a registered trademark of Bexco Pharma, Inc.; Rayvisc™ Ophthalmic Viscoelastic is a registered trademark of Rayner; and DBX® Demineralized Bone Matrix is a registered trademark of the Musculoskeletal Transplant Foundation (“MTF”).
Hyaluronan Division
Background
Hyaluronan, a naturally occurring polysaccharide, is a component of many tissues in the body and of physiological fluids that lubricate or otherwise protect the body’s soft tissues. Due to its widespread presence in tissues, critical role in normal physiology and its high degree of biocompatibility, the Company believes that hyaluronan will continue to be used for an increasing variety of medical applications. The Company produces hyaluronan through a proprietary fermentation process.
Hyaluronan was first demonstrated to have commercial medical utility as a viscoelastic solution in cataract surgery. In this application, it is used for maintaining the shape of the anterior chamber and protecting corneal tissue during the removal and implantation of intraocular lenses. The first ophthalmic hyaluronan product, produced by extraction from rooster comb tissue, became commercially available in the United States in 1981. Hyaluronan-based products, produced either by rooster comb extraction or by fermentation processes such as the Company’s, have since gained widespread acceptance in ophthalmology and are currently used in the majority of cataract extraction procedures in the world. The Company’s hyaluronan is also used as an aseptic solution which is used as a carrier vehicle for allogeneic freeze-dried demineralized bone provided to orthopedic surgeons, as a component of devices to treat the symptoms of osteoarthritis, and as a component to provide increased lubricity to medical devices. The Company’s hyaluronan has been utilized in veterinary applications as a veterinary drug and device to treat traumatic arthritis and as an embryo cryopreservation media.
Strategy
The Company intends to use its proprietary fermentation process and aseptic formulation and filling expertise to be a leader in the development of hyaluronan-based products for multiple applications and to take advantage of non-hyaluronan device and drug opportunities which leverage our expertise. Elements of the Company’s strategy include the following:
•
Establish strategic relationships with market leaders. The Company will continue to develop applications for products with partners who have strong marketing, sales and distribution capabilities to end-user markets. The Company currently has established relationships with the market leading companies Alcon and Advanced Medical Optics in ophthalmology, Novartis AG in generic devices and drugs, and MTF, the world’s largest bone tissue procurement and distribution service.
•
Expand medical applications for hyaluronan. Due to the growing knowledge of the unique characteristics of hyaluronan and the role it plays in normal physiology, the Company continues to identify and pursue further uses for hyaluronan in other medical applications, such as wound care, aesthetic surgery, adhesion prevention, drug delivery, device coatings and pharmaceuticals. Further applications may involve expanding process development activity and/or additional licensing of technology.
•
License Hyaluronan Technology from Third Parties. As part of this strategy, Lifecore entered into a world-wide exclusive license and development agreement with CCF to develop and commercialize hyaluronan-based products and related applications. The license is for patented hyaluronan-based cross-linking technology that can be used for products in aesthetics, orthopedics, ophthalmology and other medical fields. Given the broad number of applications, Lifecore anticipates that it will sublicense the technology for certain applications while retaining manufacturing rights.
•
Utilize manufacturing infrastructure to pursue contract aseptic filling and fermentation opportunities. The Company will continue to evaluate providing contract services for opportunities that are suited for the capital and facility investment related to aseptic filling equipment, fermentation and purification.
•
Maintain flexibility in product development and supply relationships. The Company’s vertically integrated development and manufacturing capabilities allow it to establish a variety of relationships with global corporate partners. Lifecore’s role in these relationships extends from supplying hyaluronan raw materials to manufacturers of aseptically-packaged, finished sterile products to developing and manufacturing our own proprietary products.
Hyaluronan Division Products
The following chart summarizes the principal products of the Hyaluronan Division, along with their applications, and the companies with which Lifecore has related strategic relationships:
PRODUCT
DESCRIPTION
MARKET
STATUS+
OPHTHALMIC
Viscoat® Intraocular
Viscoelastic
Lifecore supplies hyaluronan powder for inclusion in Alcon’s Viscoat® Opthalmic Viscoelastic.
Cataract surgery
Commercial sales
since 1986
LUROCOAT® Ophthalmic
Viscoelastic
Lifecore supplies its private label product for marketing on a non-exclusive basis.
Cataract surgery
Commercial sales since June 1997
ORTHOPEDIC
Hyaluronan Solution
for DBX® Demineralized
Bone Matrix
Lifecore supplies a sterile hyaluronan solution to MTF for use as a carrier vehicle for its allogeneic demineralized, freeze-dried bone.
Grafting material for restoration of bone defects
Commercial sales
since 2000
Hyaluron HEXAL®
Orthopedic
Viscosupplement
Lifecore supplies a finished orthopedic viscosupplement for Novartis AG’s distribution network.
Injections for the local treatment of pain associated with osteoarthritis
Commercial sales
began in fiscal
VETERINARY
HY-50®
Lifecore supplies a finished veterinary viscosupplement to Bexco Pharma, Inc. for use as a veterinary orthopedic injectable drug or device.
Veterinary
drug/device
Commercial sales
since 1993
+
For many of the products listed above, government regulatory approvals are required before commercial sales can commence in the United States or elsewhere. See “Government Regulation.” No assurance can be given that such products will be successfully approved in new markets.
Ophthalmic Applications
Cataract Surgery. Currently, a primary commercial application for the Company’s hyaluronan is in cataract surgery. Hyaluronan, in the form of a viscoelastic solution, is used to maintain a deep chamber during anterior segment surgeries (including cataract extraction and intraocular lens implantation) and to protect the corneal endothelium and other ocular tissue. These solutions have been shown to reduce surgical trauma and thereby contribute to more rapid recovery with fewer complications than were experienced prior to the use of viscoelastics. The Company currently sells hyaluronan for this application to Alcon, the leading producer of ophthalmic surgical
products in the world, for inclusion in ViscoatÒ Ophthalmic Viscoelastic. The Company also has distribution agreements with multiple companies to supply its hyaluronan based LUROCOAT® Opthalmic Viscoelastic (discussed below) under private label outside the United States and Canada.
The Company’s relationship with Alcon and its predecessors commenced in 1983. Since that time, sales of hyaluronan to Alcon have continued to be made pursuant to supply agreements. The current Alcon supply agreement, as renewed in December 2004, is a non-exclusive agreement for a term of four years through December 31, 2008.
Hyaluronan-based products are used in the majority of cataract surgeries in the world. The Company estimates that the worldwide market for hyaluronan for cataract surgery, on a hospital cost basis, is approximately $550 million per year.
The Company has developed its own viscoelastic solution, LUROCOAT® Ophthalmic Viscoelastic. The Company received CE marking for LUROCOAT Ophthalmic Viscoelastic during 1997, allowing LUROCOAT Ophthalmic Viscoelastic to be marketed and sold outside the United States. The Company supplies LUROCOAT Ophthalmic Viscoelastic under private label agreements. Export shipments of LUROCOAT Ophthalmic Viscoelastic began in 1997.
The Company signed an agreement with Advanced Medical Optics (“AMO”) to supply Lifecore’s hyaluronan based viscoelastic under private label with sales commencing in fiscal year 2005. After an initial term of three years through May 2007, the AMO agreement has been renewed through May 2009.
Lifecore estimates that its hyaluronan has been used in over 30 million ophthalmic patients globally since 1983.
Orthopedic Applications
The Company supplies an aseptic hyaluronan solution to BioCon, Inc., the non-profit controlling affiliate of MTF, which utilizes the solution as a carrier vehicle for its allogeneic demineralized, freeze-dried bone in a final putty composition trademarked as “DBXÒ Demineralized Bone Matrix”. This bone putty is provided by MTF to orthopedic surgeons through MTF’s distribution channels. The Company has a supply agreement with MTF through December 2009.
The Company also supplies a finished orthopedic viscosupplement for Novartis AG’s distribution network.
Veterinary Applications
The Company manufactures Bexco Pharma, Inc.’s HY-50® product, an aseptically packaged hyaluronan solution for use as a veterinary orthopedic device or veterinary orthopedic injectible drug, under a supply agreement expiring June 30, 2010.
Lifecore estimates that its veterinary hyaluronan product has been used in over 700,000 equine procedures worldwide.
Product Development
The Hyaluronan Division undertakes its own product development activities for hyaluronan-based applications, as well as on a contract basis with certain clients. The majority of the projects are intended to demonstrate that the Company’s hyaluronan is suitable for a particular medical application. Suitability is often measured by detailed specifications for product characteristics such as purity, stability, viscosity and molecular weight, as well as efficacy for a particular medical application in a clinical setting.
In addition, the Company has licensed a sodium hyaluronate cross-linking technology from CCF. The development activity with this technology is intended to demonstrate the efficacy in multiple medical applications.
There can be no assurance that products currently under development by the Company or in partnership with others will be successfully developed or, if so developed, will be successfully and profitably marketed.
Dental Division
Background
Dental implant systems are increasingly accepted as a replacement for missing or extracted teeth and serve as supports for dentures, crowns and bridges. In comparison to conventional restorative procedures, dental implants are surgically placed in the jawbone, simulating the anchoring of a tooth by its root. The implant maintains underlying bone structure and provides superior fixation of restorations, minimizing loosening of implants against surrounding teeth and gingiva. To further enhance osseointegration, various implant styles may be roughened to create added surface area for bone-to-implant contact. The annual worldwide dental implant market was estimated to be approximately $1.8 billion in 2006.
Bone graft substitutes and bone regeneration membranes are used for the restoration of deteriorated bone caused by periodontal disease and tooth loss. Historically, autologous bone (self-donated from another part of the patient’s own body) has been used to treat and regenerate deteriorated bone. Cadaver, synthetic and animal-derived bone graft substitutes emerged to address the issues of limited quantity and second surgical site morbidity associated with use of autologous bone. The current annual U.S. market for dental bone augmentation is approximately $111 million. The Company’s TefGen® Regenerative Membrane, CAPSET® Calcium Sulfate Bone Graft Barrier, CALFORMA® Calcium Sulfate Barrier and CALMATRIX® Calcium Sulfate Binder products, along with additional new product development, target this market opportunity.
Strategy
The Company is committed to providing the dental community with comprehensive treatment solutions and practice-building support through:
•
Development or acquisition of a broad line of dental implants, technology and related dental surgery support products that facilitate the transition from competitive systems to the Lifecore system.
•
Development and delivery of unique customer support programs and materials concentrating on the principles of tooth replacement therapy, practice management techniques, and marketing and consulting skills training to foster higher patient acceptance of dental implants.
•
Increased penetration of markets by expanded direct selling efforts.
•
Expansion of international markets and additional distribution agreements.
Dental Division Products
The following chart summarizes the principal products of the Company’s Dental Division:
PRODUCT
BENEFIT / APPLICATION
STATUS
IMPLANTS
PRIMA™ Implant System with TiLobe™
Technology
A unique, proprietary implant system. PRIMACONNEX™ incorporates TiLobe™ Technology, a six-lobed internal connection. PRIMASOLO™ is a one-piece implant that incorporates the surgical and restorative components in one unit. Both implants are available in either straight or tapered configurations and are placed using one surgical kit.
Commercial sales
RENOVA® Internal Hex Dental
Implant System
Major clinical segment utilizing internal hex connection providing increased stability; available in both straight and tapered implant systems offering flexibility of clinical treatment.
Commercial sales
PRODUCT
BENEFIT / APPLICATION
STATUS
RESTORE® External Hex Dental
Implant Systems
Time proven external hex implants with industry leading prosthetic fit and familiar surgical/restorative procedures.
Commercial sales
STAGE-1® Single Stage
Implant System
Provides the timesaving benefits of a one-stage surgical procedure with the restorative simplicity and reliability of a Morse taper prosthetic connection.
Commercial sales
Quick-Cap® Impression System
Increases the ease and efficiency of the implant restoration process.
Commercial sales
BONE REGENERATION
CALMATRIX® Calcium Sulfate
Bone Graft Binder
Combined with bone graft material, CALMATRIX® forms a putty-like composite that fills osseous or periodontal defects to regenerate bone.
Commercial sales
CALFORMA® Calcium Sulfate
Bone Graft Barrier
CALFORMA® is a shapeable putty-like containment barrier that covers intra-oral defects and provides protection and undisturbed space for regeneration.
Commercial sales
CAPSET® Calcium Sulfate Bone
Graft Barrier, including SlowSet™
Version
For use with natural and synthetic bone graft materials as a resorbable barrier cap and/or binding agent.
Commercial sales
TefGen® Regenerative Membrane
Non-resorbable membrane for assisting the regeneration of bone defects.
Commercial sales
Implant Products
The PRIMA™ Implant System design offers unprecedented clinical flexibility in a single implant system. With one or two-piece implants, a streamlined surgical kit and an array of advanced features and restorative options, the Lifecore PRIMA Implant System meets exacting standards and delivers superior clinical and esthetic results. The PRIMA Implant System was commercially launched in October 2005.
The RENOVA® Internal Hex Implant System design provides the stability of an internal hex connection, while providing surgical treatment flexibility of both straight and tapered implants, improved thread design, indexability, superior esthetics and ease of clinician handling. The RENOVA system was commercially launched in June 2004.
The RESTORE® System is based on a classic threaded titanium implant design that pioneered the commercialization of these devices in general dental surgery. In July 1993, the Company acquired this implant design in connection with its acquisition of Implant Support Systems, Inc. (“ISS”), a manufacturer of dental implant products. The Company has since enhanced and expanded the original ISS line into a broad range of implant options. The Company now markets its line of external hex implants, prosthetics and associated instrumentation under the RESTORE System name.
The STAGE-1® Single Stage Implant System was designed by the Company to allow for a one-stage surgical procedure. The STAGE-1 Implant design allows placement in a single surgical procedure that reduces treatment time. The system’s reliable Morse taper prosthetic connection simplifies restorative procedures for the dentist. Commercial sales began in September 1999. In March 2001, the Company added the RBM STAGE-1 Single Stage Implant System to this line.
The Quick-Cap® Impression System greatly improves the restorative dentist’s ease and accuracy of impressioning for subsequent laboratory construction of the final crown, bridge or denture. This system is available in both the PRIMA™ and STAGE-1® systems.
Lifecore has enhanced and expanded its product lines, creating numerous new products with a combination of innovative features from its existing systems. This gives the Company a broad product line which offers practitioners maximum flexibility in choice of treatment modalities and several innovations that enhance ease-of-use by the clinician. Additionally, the Dental Division assists its dental surgery clients by developing comprehensive continuing education curricula, as provided in the Company’s various Skills Series programs, to train restorative
clinicians and their auxiliary teams in the principles of tooth replacement therapy and practice management. The Company’s ICA program offers client personnel the marketing and selling skills training to foster higher patient acceptance of dental implants. The Support Plus Overdentures program teaches a step-by-step approach to obtain predictable and profitable results for attachment retained overdenture implant restorations.
Bone Regeneration Products
The Company offers products that address various bone and tissue regeneration procedures.
CALMATRIX® Calcium Sulfate Bone Graft Binder and CALFORMA® Calcium Sulfate Bone Graft Barrier received 510(k) clearance and were introduced to the market in fiscal 2005. The first generation of these regeneration products, CAPSET® Calcium Sulfate Bone Graft Barrier, received 510(k) clearance and was introduced to the market in 1995. CAPSET SlowSet™ Barrier was introduced in July 1999. These products are based on a proprietary medical grade calcium sulfate technology developed by and licensed from Wright Medical Group, Inc., an orthopedic product manufacturer based in Memphis, Tennessee. The products provide guided bone regeneration containment barriers to prevent migration of bone graft materials used to fill oral bone defects.
TefGen® Regenerative Membrane technology was acquired by the Company from Bridger Biomed, Inc. in May 1997. This non-resorbable membrane is based on nanoporous PTFE Biomaterials (“nPTFE”) and is competitive with the market’s leading product produced by W.L. Gore. A TefGen Regenerative Membrane allows the dental surgeon to cover treated defects in bone to prevent the invasion of unwanted soft tissue while the slower growing bone tissue underneath the membrane regenerates.
Product Development
The Dental Division is also involved in product development activities to improve existing components and packaging and to add new components to the dental implant systems. These development activities enhance the suitability and ease-of-use of the products for specific surgical applications and reflect changing trends in dental implant technology. There can be no assurance, however, that products which are currently under development by the Company will be successfully developed, or if so developed, will be successfully and profitably marketed.
Sales and Marketing
Hyaluronan Division Products
The Company generally markets and distributes its hyaluronan products to end-users through corporate partners. The Company sells hyaluronan to these partners in a variety of forms, including powders, gels and solutions packaged in bulk or single-application units. Sales to Alcon were 13%, 13% and 16% of total consolidated sales in 2007, 2006 and 2005, respectively.
The Company also sells various forms of medical grade hyaluronan directly to academic and corporate research customers for development and evaluation of new applications.
Dental Division Products
The Company is focused on expanding its dental product line and developing increased sales and marketing support. The dental implant market is highly specialized. Products are marketed to oral surgeons, periodontists, implantologists, prosthodontists, general dental practitioners and dental laboratories. Accordingly, management believes it must maintain a highly experienced direct sales force in the United States for proper distribution of these products. The Company believes that its sales force offers better customer service, technical support and regulatory control than could be achieved through an independent distributor network in the United States. The Company employs a dedicated sales force in the United States as well as U.S.-based international sales personnel. The Dental Division products are marketed internationally in 49 countries through 28 distributors and in Italy through the Company’s subsidiary, Lifecore Biomedical SpA, in Germany through the Company’s subsidiary, Lifecore Biomedical GmbH, in France through the Company’s subsidiary, Lifecore Biomedical SAS, and in Scandinavia through the Company’s subsidiary, Lifecore Biomedical AB.
The Company’s marketing activities are designed to support its direct domestic sales force and its international business base, and include advertising and product publicity in trade journals, direct mail, catalogs, newsletters, continuing education programs, telemarketing, and attendance at trade shows and professional
association meetings. Industry estimates indicate a need for replacement of approximately 100 million teeth in the adult population of the United States. That represents a potential implants and accessories market of approximately $20 billion compared to the actual current U.S. market size of approximately $625 million.
Manufacturing
The commercial production of hyaluronan by the Company requires fermentation, separation and purification capabilities, and aseptic packaging of product in a variety of bulk and single dose configurations.
The Company produces its hyaluronan through a proprietary fermentation process. Until the introduction of the Company’s medical grade hyaluronan, the only commercial source for medical hyaluronan was through a process of extraction from rooster combs. The Company believes that the fermentation manufacturing approach is superior to rooster comb extraction because of greater efficiency and flexibility, a more favorable long-term regulatory environment, and better economies of scale in producing large commercial quantities.
The Company’s 110,000 square foot facility is primarily used for the proprietary hyaluronan manufacturing process, formulation and aseptic syringe and bulk filling. The Company believes that the current inventory on-hand, together with its manufacturing capacity, will be sufficient to allow it to meet the needs of its current customers for the foreseeable future.
The Company provides versatility in the manufacturing of various types of finished products. Currently, the Company supplies several different forms of hyaluronan in a variety of molecular weight fractions as powders, solutions and gels, and in a variety of bulk and single-use finished packages. The Hyaluronan Division continues to conduct development work designed to improve production efficiencies and expand the Company’s capabilities to achieve a wider range of hyaluronan product specifications in order to address the broadening opportunities for using hyaluronan in medical applications.
The Company’s facility was designed to meet applicable regulatory requirements and has been cleared for the manufacture of both device and pharmaceutical products. The FDA periodically inspects the Company’s manufacturing systems and requires conformance to the FDA’s Quality Systems Regulations (“QSR”). In addition, the Company’s corporate partners conduct intensive quality audits of the facility. The Company also periodically contracts with independent regulatory consultants to conduct audits of the Company’s operations. The Company maintains a Quality System which assures conformance to all applicable current standards (21 CFR820, 21 CFR210-211, ISO 13485:2003, 93/42/EEC, and Canadian Medical Device Regulation:1998). These approvals represent international symbols of quality system assurance and compliance with applicable European Medical Device Directives, which greatly assist in the marketing of the Company’s products in the European Union.
The Company uses outside metal finishing vendors to produce its dental implant devices and related components. The Company inspects vendors’ quality assurance and control functions and performs its own finished packaging related to the implant product lines.
The Company purchases raw materials for its production of hyaluronan and calcium sulfate-based products from outside vendors. While these materials are available from a variety of sources, the Company principally uses limited sources for some of its key materials to better monitor quality and achieve cost efficiencies. Wright Medical Group, Inc. exclusively supplies the key raw material for the calcium sulfate-based products. The Company believes Wright Medical Group, Inc. is able to provide adequate amounts of the raw materials and is under a supply agreement with the Company through September 2009. The Company utilizes a supply agreement with Bridger Biomed, Inc. to supply the TefGen® Regenerative Membrane product line.
Competition
The competitors of the Company include major chemical, dental, medical and pharmaceutical companies, as well as smaller specialized firms. Many of these companies have significantly greater financial, manufacturing, marketing and research and development resources than the Company.
Hyaluronan Products
A number of companies produce hyaluronan products and thus directly or indirectly compete with Lifecore or its corporate partners. Several companies produce hyaluronan through a fermentation or extraction process, including Seikagaku, Genzyme Corporation, Savient, Fidia SpA, Kyowa Hakko, Kibun, Advanced Medical Optics, Bayer and others. The Company believes that its fermentation process offers production and regulatory advantages over the traditional rooster comb extraction method. The Company’s competitors have filed or obtained patents covering aspects of fermentation production or uses of hyaluronan. These patents may cover the same applications as the Company’s patents. See “Patents and Proprietary Rights.”
The Company believes that competition in the ophthalmic and medical grade hyaluronan market is primarily based on product performance, manufacturing capacity and product development capabilities. Future competition may be based on the existence of established supply relationships, regulatory approvals, intellectual property and product price. After a manufacturer has taken a product through the FDA marketing approval process, a change in suppliers can involve costs and delays because supplemental FDA review may be required.
Dental Products
The dental implant market is also highly competitive. Major market competitors include Nobel Biocare Holding AB Group, Straumann Holding AG, Biomet, Inc., Zimmer Dental, AstraZeneca PLC and Dentsply International, Inc. A number of these competitors are established companies with dominant market shares. The Company believes that competition in the dental implant market is based primarily on product performance and quality, strong sales support and education.
The Company believes that its broad product line facilitates the conversion of competitive implant users to a Lifecore system. In addition, the Company has developed several innovative education and marketing support programs which are designed to increase the client’s implant business. The Company believes it has established a strong reputation for quality products due to its stringent design and inspection criteria. No assurance can be given, however, that the Company can effectively compete with other manufacturers of dental implant systems.
The market for the Company’s tissue regeneration products is also competitive. The major competitors include Biomet, Inc., Dentsply International, Inc., Geistlich, W. L. Gore (GORE-TEX), Straumann Holding AG and Zimmer Dental. While the Company believes its product line and experienced sales representation are an advantage in this area, no assurance can be given that it can gain significant market share from its more established competitors.
Patents and Proprietary Rights
The Company pursues a policy of obtaining patent protection for patentable subject matter in its proprietary technology. In May 1985, the Company received a U.S. patent covering certain aspects of its hyaluronan fermentation process. The Company exclusively licensed patents and patent applications from CCF covering certain hyaluronan cross-linking technologies. The Company licenses two patents covering the dental surgical use of calcium sulfate from Wright Medical Group, Inc. The Company also licenses patented technology used in the production of calcium sulfate from Wright Medical Group, Inc. and the University of North Carolina. In conjunction with the purchase of the TefGen® Regenerative Membrane product line, the Company obtained the rights to the patent for composition, manufacture and use of the nPTFE material. The Company has received a patent on its dental implant packaging and a patent on a self-tapping dental implant design.
The Company believes that patent protection is important to its business. However, if other manufacturers were to infringe on its patents, there can be no assurance that the Company would be successful in challenging, or would have adequate resources to challenge, such infringement. The Company also relies upon trade secrets, proprietary know-how and continuing technological innovation to develop and maintain its competitive position. There can be no assurance that others will not obtain or independently develop technologies which are the same as or similar to the Company’s technologies. The Company pursues a policy of requiring employees, temporary staff, consultants and customers (which have access to some of its proprietary information) to sign confidentiality agreements. There can be no assurance that the Company will be able to adequately protect its proprietary technology through patents or other means.
The Company is aware that one or more of its competitors have obtained, or are attempting to obtain, patents covering fermentation and other processes for producing hyaluronan. Other patents have been, or may be, issued in the future in product areas of interest to the Company. Although the Company is not aware of any claims
that its current or anticipated products infringe on patents held by others, no assurance can be given that there will not be an infringement claim against the Company in the future. The costs of any Company involvement in legal proceedings could be substantial, both in terms of legal costs and the time spent by management of the Company in connection with such proceedings. It is also possible that the Company may be required to obtain additional licenses to manufacture and market some of its products which may require the payment of initial fees, minimum annual royalty fees and ongoing royalties on net sales. There can be no assurance that the Company would be able to license technology developed by others, on favorable terms or at all, that may be necessary for the manufacture and marketing of its products.
Government Regulation
Government regulation in the United States and other countries is a significant factor in the marketing of the Company’s products and in the Company’s ongoing research and development activities. The Company’s products are subject to extensive and rigorous regulation by the FDA, which regulates the products as medical devices and which, in some cases, requires Pre-Market Approval (“PMA”), and by foreign countries, which regulate the products as medical devices or drugs. Under the Federal Food, Drug, and Cosmetic Act (“FDC Act”), the FDA regulates the clinical testing, manufacturing, labeling, distribution, sale and promotion of medical devices in the United States.
Following the enactment of the Medical Device Amendments of 1976 to the FDC Act, the FDA classified medical devices in commercial distribution at the time of enactment (“pre-Amendment devices”) into one of three classes - Class I, II or III. This classification is based on the controls necessary to reasonably assure the safety and effectiveness of medical devices. Class I devices are those whose safety and effectiveness can reasonably be assured through general controls, such as establishment registration and labeling, and adherence to FDA-mandated current QSR requirements for devices. Most Class I devices are exempt from FDA premarket review, but some require premarket notification (“510(k) Notification”). Class II devices are those whose safety and effectiveness can reasonably be assured through the use of special controls, such as performance standards, postmarket surveillance, patient registries and FDA guidelines. Class III devices are devices that require a PMA from the FDA to assure their safety and effectiveness. A PMA ordinarily must contain data from a multi-center clinical study demonstrating the device’s safety and effectiveness for the intended use and patient population. Class III devices are generally life-sustaining, life-supporting or implantable devices, and also include most devices that were not on the market before May 28, 1976 (“new devices”) and for which the FDA has not made a finding of substantial equivalence based upon a 510(k) Notification. A pre-Amendment Class III device does not require a PMA unless and until the FDA issues a regulation requiring submission of a PMA application for the device.
The FDA requires clinical data for a PMA application and has the authority to require such data for a 510(k) Notification. If clinical data are necessary, the company that sponsors the study must follow the FDA’s Investigational Device Exemption (“IDE”) regulations governing the conduct of human studies. The FDA’s regulations require institutional review board approval of the study and the informed consent of the study subjects. In addition, for a “significant risk” device, the FDA must approve an IDE application before the study can begin. Nonsignificant risk devices do not require FDA approval of an IDE application, and are conducted under the “abbreviated IDE” requirements. Once in effect, an IDE or abbreviated IDE permits evaluation of devices under controlled clinical conditions. After a clinical evaluation process, the resulting data may be included in a PMA application or a 510(k) Notification. The PMA may be approved or the 510(k) Notification may be cleared by the FDA only after a review process that may include FDA requests for additional data, sometimes requiring further studies.
If a manufacturer or distributor of medical devices can establish to the FDA’s satisfaction through a 510(k) Notification that a new device is substantially equivalent to what is called a “predicate device,” i.e., a legally marketed Class I or Class II medical device or a legally marketed pre-Amendment Class III device for which the FDA has not required a PMA, the manufacturer or distributor may market the new device. In the 510(k) Notification, a manufacturer or distributor makes a claim of substantial equivalence, which the FDA may require to be supported by various types of information, including data from clinical studies, showing that the new device is as safe and effective for its intended use as the predicate device.
Following submission of the 510(k) Notification, the manufacturer or distributor may not place the new device into commercial distribution until the FDA issues a “substantial equivalence” determination finding the new device to be substantially equivalent to a predicate device. The FDA has a 90 day period in which to respond to a 510(k) Notification (Traditional or Abbreviated 510(k); 30 days for a Special 510(k)). Depending on the specific submission and subsequent agency information requests, the 510(k) Notification process can take significantly
longer to complete. The FDA may agree with the manufacturer or distributor that the new device is substantially equivalent to a predicate device and allow the new device to be marketed in the United States. The FDA may, however, determine that the new device is not substantially equivalent and require the manufacturer or distributor to submit a PMA or require further information, such as additional test data, including data from clinical studies, before it is able to make a determination regarding substantial equivalence. Although the PMA process is significantly more complex, time-consuming and expensive than the 510(k) Notification process, the latter process can also be expensive and substantially delay the market introduction of a product. Modifications to a device that is marketed under a 510(k) Notification might require submission of a new 510(k) prior to their implementation, although some modifications can be made through a “note to file” procedure described in FDA guidance.
For devices that cannot be found “substantially equivalent” to a predicate device, the manufacturer must submit a PMA application, petition for reclassification, or submit a PMA application via the de novo process. A PMA must contain information on the materials and manufacturing process for the device, results of preclinical testing, clinical data, and labeling for the device. The FDA has 180 days to review a PMA application, but may request additional information, which could include additional studies. The FDA might refer a PMA to an advisory committee of outside experts to review and make recommendation on whether a device should be approved. After considering the data in the PMA application and the recommendations of an advisory committee, the FDA can approve the device, approve the device with conditions or refuse approval. Devices approved by the FDA are subject to periodic reporting requirements, and may be subject to restrictions on sale, distribution or use.
Hyaluronan products are generally Class III devices. In cases where the Company is supplying hyaluronan to a corporate partner as a raw material or producing a finished product under a license for the partner, the corporate partner will be responsible for obtaining the appropriate FDA clearance or approval. Export of the Company’s hyaluronan products generally requires approval of the importing country and compliance with the export provisions of the FDC Act. The Company’s Dental products are Class I and Class II devices.
Other regulatory requirements are placed on the manufacture, processing, packaging, labeling, distribution, recordkeeping and reporting of a medical device and on the quality control procedures, such as the FDA’s device QSR regulations. Manufacturing facilities are subject to periodic inspections by the FDA to assure compliance with device QSR requirements. The Company’s facility is subject to inspections as both a device and a drug manufacturing operation. For PMA devices, the Company is required to submit an annual report and to obtain approval of a PMA supplement for modifications to the device or its labeling. Other applicable FDA requirements include the medical device reporting (“MDR”) regulation, which requires that the Company provide information to the FDA regarding deaths or serious injuries alleged to have been associated with the use of its devices, as well as product malfunctions that would likely cause or contribute to death or serious injury if the malfunction were to recur. The FDA also requires reporting regarding notices of correction and the removal of a medical device.
If the Company is not in compliance with FDA requirements, the FDA or the federal government can order a recall, detain the Company’s devices, refuse to grant 510(k) Notification clearances or PMA approvals, withdraw or limit product approvals, institute proceedings to seize the Company’s devices, seek injunctions to control or prohibit marketing and sales of the Company’s devices, assess civil money penalties and impose criminal sanctions against the Company, its officers or its employees.
There can be no assurance that any of the Company’s clinical studies will show safety or effectiveness; that 510(k) Notifications or PMA applications or supplemental applications will be submitted or, if submitted, accepted for filing; that any of the Company’s products that require clearance of a 510(k) Notification or approval of a PMA application or PMA supplement will obtain such clearance or approval on a timely basis, on terms acceptable to the Company for the purpose of actually marketing the products, or at all; or that following any such clearance or approval previously unknown problems will not result in restrictions on the marketing of the products or withdrawal of clearance or approval.
Product Liability
Product liability claims may be asserted with respect to the Company’s products. In addition, the Company may be subject to product liability claims for the products of its customers that incorporate Lifecore’s materials. The Company maintains product liability insurance coverage in amounts the Company deems to be adequate. Lifecore Biomedical SpA and Lifecore GmbH also carry product liability insurance. There can be no assurance that the Company will have sufficient resources to satisfy product claims if they exceed available insurance coverage.
Seasonality
The Company’s business is seasonal in nature. Historically, sales in the Dental Division are lower in the first quarter than the rest of the year as a result of European holidays during the summer months.
Employees
As of August 22, 2007 the Company employed 241 persons on a full-time basis, 14 part-time employees and 4 temporary employees. None of the Company’s employees is represented by a labor organization, and the Company has never experienced a work stoppage or interruption due to labor disputes. Management believes its relations with employees are good.
Executive Officers of the Registrant
The following sets forth the names of the executive officers of Lifecore, in addition to information about their positions with Lifecore, their periods of service in such capacities, and their business experience for at least the past five years. There are no family relationships among them. All executive officers listed were appointed by the Board of Directors for a term of office from the time of appointment until the next annual meeting of directors (held in conjunction with the annual meeting of shareholders) and until their respective successors are elected and have qualified.
Dennis J. Allingham. Mr. Allingham, 56 years old, was appointed President and Chief Executive Officer and to the Board of Directors in February 2004. Mr. Allingham previously served as Executive Vice President of the Company from November 1997 to February 2004. He served as Chief Financial Officer of the Company from January 1996 to March 2004. Mr. Allingham also served as General Manager of the Hyaluronan Division from November 1996 to February 2004 and General Manager of the Dental Division from November 1997 to February 2004.
James G. Hall. Mr. Hall, 44 years old, was appointed Vice President of Technical Operations in July 2006. Mr. Hall served as the Company’s Director of Manufacturing Operations and Engineering from 2001 to July 2006; prior to that he was the Manager of Engineering and Operations at Lifecore. Mr. Hall has over 17 years of drug and device manufacturing experience and was with Protein Design Labs, a biomaterials company, prior to joining Lifecore.
Larry D. Hiebert. Mr. Hiebert, 52 years old, was appointed Vice President and General Manager of the Hyaluronan Division in July 2006. Mr. Hiebert served as Vice President of Operations from March 2004 to July 2006, Director of Operations from 1997 to March 2004 and held various manufacturing and materials management positions within the Company from 1983 to March 2004.
David M. Noel. Mr. Noel, 50 years old, was appointed Vice President of Finance and Chief Financial Officer in March 2004. Mr. Noel, a Certified Public Accountant, joined the Company as Controller in February 2002 and served in such position until March 2004. From 1996 to 2001, Mr. Noel was Controller of Nilfisk-Advance, Inc., a manufacturer of floor maintenance equipment.
Kipling Thacker, Ph.D. Dr. Thacker, 52 years old, was appointed Vice President of New Business Development in November 2004. Dr. Thacker served as Director of New Business Development from 2000 to November 2004 and is the co-inventor of the hyaluronan fermentation and manufacturing process. He held various research and business development positions at the Company from 1981 to 2004.
Item 1A.
Item 1A. Risk Factors
The Company’s business faces many risks. Any of the risks discussed below, or elsewhere in this Form 10-K or the Company’s other filings with the Securities and Exchange Commission, could have a material impact on the Company’s business, financial condition or results of operations. Additional risks and uncertainties not presently known to the Company or that the Company currently believes to be immaterial may also impair the Company’s business operations.
The Company’s business could be adversely affected if it is not able to successfully compete against competitors in the human health care products industry.
Competitors of the Hyaluronan and Dental Divisions in the United States and elsewhere are numerous and include major chemical, dental, medical, and pharmaceutical companies, as well as smaller specialized firms. Many of these competitors have substantially greater capital resources, marketing experience, and research and development resources than the Company. These companies may succeed in developing products that are more effective than any that have been or may be developed by Lifecore and may also prove to be more successful than Lifecore in producing and marketing these products. In addition, the Dental Division is competing against a number of large established competitors. In order to increase sales, the Dental Division may need to gain market share from its competitors. There can be no assurance that Lifecore will be able to continue to compete successfully against these competitors.
Several companies produce hyaluronan through a fermentation or extraction process, including Seikagaku, Genzyme Corporation, Savient, Fidia SpA, Kyowa Hakko, Kibun, Advanced Medical Optics, Bayer and others. In addition, several companies manufacture hyaluronan by using rooster comb extraction methods. These companies primarily include Anika Therapeutics, Inc., Genzyme Corporation, Fidia SpA, AMO, Seikagaku and others. The Company’s competitors have filed or obtained patents covering aspects of fermentation production or uses of hyaluronan. These patents may cover the same applications as the Company’s applications. Although the Company believes that it does not infringe the patents of its competitors, there can be no assurance that the Company will not receive claims of infringement from third parties.
In addition, negative announcements regarding any competitor’s products may have a negative impact on the public’s perception of the market potential for all similar products, including the Company’s products. There can be no assurance that product introductions by present or future competitors or future technological or health care innovations will not render Lifecore’s products and processes obsolete.
If Lifecore is unable to successfully protect its proprietary technology or if it is unable to maintain a competitive technological position in its product areas, its business could be adversely affected.
While certain of Lifecore’s patents have been allowed or issued, there can be no assurance that, to the extent issued, the Company’s patents will effectively protect its proprietary technology. If other manufacturers were to infringe on its patents, there can be no assurance that the Company would be successful in challenging, or would have adequate resources to challenge, such infringement. Lifecore also relies upon trade secrets, proprietary know-how and continuing technological innovation to develop and maintain its competitive position. There can be no assurance that others will not independently develop such know-how or otherwise obtain access to the Company’s technology. While Lifecore’s employees, temporary staff, consultants and corporate partners with access to proprietary information are required to enter into confidentiality agreements, there can be no assurance that these agreements will provide the Company with adequate protection from loss of proprietary technology or know-how.
Under current law, patent applications in the United States are maintained in secrecy until patents are issued, and patent applications in foreign countries are maintained in secrecy for a period after filing. The right to a device patent in the United States is attributable to the first to invent the device, not the first to file a patent application. Accordingly, the Company cannot be sure that its products or technologies do not infringe patents that may be granted in the future pursuant to pending patent applications. The Company has not received any notices alleging, and is not aware of any infringement by the Company of any other entity’s patents relating to the Company’s current or anticipated products. There can be no assurance, however, that its products do not infringe any patents or proprietary rights of third parties. In the event that any relevant claims of third-party patents are upheld as valid and enforceable, the Company could be prevented from selling its products or could be required to obtain licenses from the owners of such patents or be required to redesign its products or processes to avoid infringement. There can be no assurance that such licenses would be available or, if available, would be on terms acceptable to the Company or that the Company would be successful in any attempt to redesign its products or processes to avoid infringement. The Company’s failure to obtain these licenses or to redesign its products or processes would have a material adverse effect on the Company’s business, financial condition, and results of operations.
The Company’s business could be adversely affected if it is unable to obtain regulatory approval for new product introductions or to expand sales of existing products into new markets.
The Company’s products under development are considered to be medical devices and, therefore, require clearance or approval by the FDA before commercial sales can be made in the United States. The products also
require the approval of foreign government agencies before sales may be made in many other countries. The process of obtaining these clearances or approvals varies according to the nature and use of the product. It can involve lengthy and detailed laboratory and clinical testing, sampling activities and other costly and time-consuming procedures. There can be no assurance that any of the required clearances or approvals will be granted on a timely basis, if at all.
In addition, most of the existing products being sold by the Company and its customers are subject to continued regulation by the FDA, various state agencies and foreign regulatory agencies which regulate manufacturing, labeling and record keeping procedures for such products. Marketing clearances or approvals by these agencies can be withdrawn due to failure to comply with regulatory standards or the occurrence of unforeseen problems following initial clearance or approval. These agencies can also limit or prevent the manufacture or distribution of the Company’s products. A determination that the Company is in violation of such regulations could lead to the imposition of civil penalties, including fines, product recalls or product seizures, injunctions, and, in extreme cases, criminal sanctions.
The Company is exposed to the risks of operating a global business, including risks associated with exchange rate fluctuations, legal and regulatory changes and the impact of regional and global economic disruptions, which could have an adverse effect on the Company’s business.
International shipments accounted for 50% of net sales in fiscal 2007. We expect that international shipments will continue to represent a significant percentage of net sales in the future. Our non-U.S. sales, purchases and operations are subject to risks inherent in conducting business abroad, many of which are outside our control, including the following:
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Periodic local or geographic economic downturns and unstable political conditions;
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Price and currency exchange controls;
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Fluctuation in the relative values of currencies;
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Difficulties protecting intellectual property;
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Local labor disputes;
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Shipping delays and disruptions;
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Increases in shipping costs, caused by increased fuel costs or otherwise, which we may not be able to pass on to our customers;
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Unexpected changes in trading policies, regulatory requirements, tariffs and other barriers; and
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Difficulties in managing a global enterprise, including staffing, collecting accounts receivable, managing suppliers, distributors and representatives, and repatriation of earnings.
Our business and operating results are subject to uncertainties arising out of the possibility of regional or global economic disruptions (including those resulting from natural disasters and outbreaks of infectious disease), the economic consequences of military action or terrorist activities and associated political instability, and the impact of heightened security concerns on domestic and international travel and commerce. In particular, due to these uncertainties we are subject to:
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The risk of more frequent instances of shipping delays; and
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The risk that demand for our products may not increase or may decrease.
The development of new hyaluronan products entails substantial risk of failure and uncertainty related to timing, and a significant amount of the Company’s anticipated growth is dependent on its ability to develop, manufacture and market new product applications for hyaluronan.
A significant amount of the Company’s anticipated growth is dependent on its ability to develop, manufacture and market new product applications for hyaluronan. Such formulations must be developed, tested and, in most cases, approved for use by appropriate government agencies. Once approved as products, they must be manufactured in commercial quantities and marketed successfully. Each of these steps involves significant amounts of time and expense. There can be no assurance that any of these products, if and when fully developed and tested,
will perform in accordance with the Company’s expectations, that necessary regulatory approvals will be obtained in a timely manner, if at all, or that these products can be successfully and profitably produced and marketed.
The Company is dependent on the marketing and development support from corporate partners for the sales growth of the Hyaluronan Division, and the Company’s business could be adversely affected if the Company’s strategic alliances fail to develop or market products as planned.
The Company has historically developed, manufactured and marketed its Hyaluronan Division products through long-term strategic alliances with corporate partners. In the case of such relationships, the speed and other aspects of the development project are sometimes outside of the Company’s control as the other party to the relationship often has priorities that differ from those of the Company. Thus, the timing of commercialization of the Company’s products under development may be subject to unanticipated delays.
Further, the Company currently has limited direct sales capabilities in the Hyaluronan Division and generally relies upon its corporate partners for marketing and distribution to end-users. The market success of the Company’s hyaluronan products generally will depend upon the size and skill of the marketing organizations of the Company’s corporate partners, as well as the level of priority assigned to the marketing of the Company’s products by these entities, which may differ from the Company’s priorities. Should one or more of the Company’s strategic alliances fail to develop or market products as planned, the Company’s business may be adversely affected. No assurance can be given that the Company will be able to negotiate acceptable strategic alliances in the future or that current strategic alliances will continue.
The development contracts into which the Company enters with corporate partners are long-term agreements that are subject to development milestones, product specifications and other terms. Consequently, future agreement often is required regarding the course and nature of continued development activities. Contractual issues requiring resolution between the parties have arisen in the past and are expected to arise in the ordinary course of the Company’s future development activities. There can be no assurance that all such issues will be successfully resolved.
If the Company is unable to scale up manufacturing operations in the event of a significant increase in customer demand, the Company’s business could be adversely affected.
The Company has designed its modular facility to permit the production of hyaluronan at levels exceeding current levels of production. However, in the event of a sudden significant increase in demand for any of the Company’s hyaluronan products, the Company will be required to scale-up operations, including the acquisition and validation of additional equipment and training of additional personnel. No assurance can be given that the Company will be able to adequately meet any such demands on a timely basis.
An interruption in the Company’s manufacturing activities could adversely affect the Company’s relations with its customers.
The Company’s manufacturing requires extensive specialized equipment. In addition, the Company manufactures its hyaluronan products at one facility. Although the Company has contingency plans in effect for certain natural disasters, as well as other unforeseen events that could damage the Company’s facilities or equipment, no assurance can be given that any such events will not materially interrupt the Company’s business. In the event of such an occurrence, the Company has business interruption insurance to cover lost revenues and profits. However, such insurance would not compensate the Company for the loss of opportunity and potential adverse impact on relations with existing customers created by an inability to produce its products.
The markets for the Company’s dental products are very competitive, and the Company’s results of operations and financial condition could be adversely affected if it cannot maintain or increase the market share of these products.
The Dental Division markets its products through a direct sales force and a distribution network. Continued growth of the Company’s revenues from dental products will depend on the ability of this sales and distribution network to increase the Company’s market share by convincing practitioners to use the Company’s products over competing established products. No assurance can be given that the sales and distribution network will be successful in increasing or maintaining the Company’s market share or sales levels. Failure to maintain and increase the market share of these products would adversely affect the Company’s results of operations and financial condition.
The Company may be subject to product liability claims and other legal proceedings which could have a material adverse effect on the Company’s business, financial condition and results of operations.
The manufacture and sale of the Company’s products entails a risk of product liability claims. In addition to product liability exposure for its own products, the Company may be subject to claims for products of its customers which incorporate Lifecore’s materials. The Company maintains product liability insurance coverage in amounts it deems adequate. However, there can be no assurance that the Company will have sufficient resources if claims exceed available insurance coverage. In addition, other types of claims may arise that are not covered by such insurance.
Lifecore was named as a defendant in 81 product liability lawsuits, all of which alleged that the plaintiffs suffered injuries due to the defective nature of INTERGEL Solution manufactured by Lifecore and marketed by ETHICON. On September 20, 2006, settlement documents relating to all but one of the lawsuits remaining at that date were executed on behalf of the parties. The terms of the settlement do not call for any cash payment by the Company. Since the execution of the settlement documents, Lifecore has been sued in two additional lawsuits, one filed in Nebraska and one in Colorado, and the one remaining lawsuit from the original 81 has been settled. Although the vast majority of the INTERGEL Solution claims have been resolved, there can be no assurance that other related claims will not arise. In addition, on September 25, 2006, Vital Pharma, Inc. (“Vital Pharma”) and its insurer, Noetic Specialty Insurance Company (“Noetic”), sued the Company and its insurer, Federal Insurance Company, for failing to fully defend and indemnify Vital Pharma in the INTERGEL Solution lawsuits. It is the Company’s understanding that Federal Insurance Company has paid Vital Pharma what Federal believes is the reasonable portion of the legal fees and expenses submitted to it for reimbursement. Vital Pharma and Noetic are seeking reimbursement of all of the legal fees and expenses incurred in the INTERGEL Solution litigation. The Company believes that Vital Pharma’s and Noetic’s claims have no merit, however there is no assurance that this will be the outcome.
There can be no assurance that these pending claims, other new product liability claims, claims with respect to uninsured liabilities or claims in excess of insured liabilities, will not have a material adverse effect on the business, financial condition and results of operations of the Company. In addition, there can be no assurance that insurance will continue to be available to the Company and that, if available, the insurance will be available on commercially acceptable terms.
Failure to maintain effective internal controls could have a material adverse effect on the Company’s business, operating results and stock price.
In connection with our fiscal 2007 audit, we documented and tested our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent registered public accounting firm addressing these assessments. If we fail to maintain the adequacy of our internal controls, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Moreover, effective internal controls, particularly those related to revenue recognition, are necessary for us to produce reliable financial reports and are important to prevent financial fraud. If we cannot provide reliable financial reports or prevent fraud, our business and operating results could be harmed, investors could lose confidence in our reported financial information and the trading price of our stock could drop significantly.
The Company’s tax rates are subject to fluctuation, which could impact its financial position, and its estimates of tax liabilities may be subject to audit, which could result in additional assessments.
Our effective tax rates are subject to fluctuation as the income tax rates for each year are a function of: (a) the effects of a mix of profits (losses) earned by Lifecore and its subsidiaries in numerous tax jurisdictions with a broad range of income tax rates, (b) our ability to utilize recorded deferred tax assets, and (c) changes in tax laws or the interpretation of such tax laws. Changes in the mix of these items may cause our effective tax rates to fluctuate between periods, which could have a material adverse effect on our financial position.
We are subject to income taxes in both the United States and foreign jurisdictions. During the ordinary course of business there are many transactions and calculations for which the ultimate tax determination is uncertain. Significant judgment is exercised in determining our world wide provisions for income taxes.
The Company’s business could be adversely affected if it were to lose the services of its key management employees.
The Company’s success depends in large part upon the services of its executive officers. The executive officers consist of Dennis J. Allingham, President and Chief Executive Officer; David M. Noel, Vice President of Finance and Chief Financial Officer; Larry Hiebert, Vice President and General Manager of the Hyaluronan Division; James G. Hall, Vice President of Technical Operations; and Kipling Thacker, Ph.D., Vice President of New Business Development. The loss of any one of these individuals may have a material adverse effect on the Company’s business and operations. The Company does not have employment agreements with, or life insurance on, its officers.
Market prices for securities of medical technology companies are highly volatile, and the trading price of the Company’s Common Stock is subject to significant fluctuations.
Market prices in the United States for securities of medical technology companies can be highly volatile, and the trading price of the Company’s Common Stock could be subject to significant fluctuations in response to quarterly variations in operating results, announcements of the status or results of development projects or technological innovations by the Company or its competitors, government regulation and other events or factors. The volatility in market prices may be unrelated to the operating performance of particular companies. These market fluctuations have in the past materially adversely affected the market price of the Company’s Common Stock, and may have such an effect in the future.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
The Company’s operations are all conducted in its 110,000 square foot building in Chaska, Minnesota, which is owned by the Company and subject to a Mortgage and Security Agreement. The Company completed an expansion of its facility during fiscal 1998. The Company leases local office space for its four foreign subsidiaries.
Item 3.
Item 3. Legal Proceedings
The Company has been named as a defendant in 81 product liability lawsuits. The lawsuits alleged that the plaintiffs suffered injuries due to the defective nature of GYNECARE INTERGEL Adhesion Prevention Solution (“INTERGEL Solution”) which was manufactured by the Company and marketed by ETHICON, Inc. (“ETHICON”). The other defendants in these lawsuits were ETHICON, which was the Company’s exclusive worldwide marketing partner for INTERGEL Solution through its division, GYNECARE Worldwide, and Johnson & Johnson, the parent company of ETHICON. Many of the lawsuits also named Vital Pharma, Inc. (“Vital Pharma”) as a defendant; Vital Pharma acted as the contract packager for the INTERGEL Solution. The plaintiffs in these actions were individuals who were patients in medical procedures during which INTERGEL Solution was used and who were allegedly injured due to the defective nature of INTERGEL Solution.
On September 20, 2006, settlement documents relating to all but one of the lawsuits remaining at that date were executed on behalf of the parties. The terms of the settlement do not call for any cash payment by the Company. Since the execution of the settlement documents, Lifecore has been sued in two additional lawsuits, one filed in Nebraska and one in Colorado, and the one remaining lawsuit from the original 81 has been settled. As of this date, there are two cases remaining: Brandy R. Kreifel and Tammy Lynder v. Gynecare, Inc., Ethicon, Inc., Lifecore Biomedical, Inc. and Johnson & Johnson Company in the District Court of Lancaster County, Nebraska, and Margaret S. Madden v. Gynecare Worldwide, et al. in U.S. District Court, District of Colorado. Although the vast majority of the INTERGEL Solution claims have been resolved, there can be no assurance that other related claims will not arise.
ETHICON defended the Company in all of these lawsuits and is defending the Company in the two remaining lawsuits. Under the terms of the Company’s Conveyance, License, Development and Supply Agreement dated August 8, 1994 with ETHICON, ETHICON is obligated to indemnify and hold the Company harmless from all claims related to the sale and use of INTERGEL Solution, unless it is ultimately determined that a plaintiff’s injuries were caused by a breach of the Company’s limited contractual warranty to ETHICON under that agreement.
The Company believes that ETHICON will be obligated to fully indemnify the Company in connection with any remaining claims relating to INTERGEL Solution sold prior to its voluntary market withdrawal in March 2003.
On September 25, 2006, Vital Pharma and its insurer, Noetic Specialty Insurance Company (“Noetic”), sued the Company and its insurer, Federal Insurance Company, in Palm Beach County, Florida. Federal Insurance Company has removed the case to federal court and the Company has filed an answer denying the claims. Vital Pharma and Noetic contend that the Company has breached the terms of the Supply Agreement between the Company and Vital Pharma by failing to fully defend and indemnify Vital Pharma in the INTERGEL Solution lawsuits. Vital Pharma and Noetic are seeking reimbursement of legal fees and expenses incurred in the INTERGEL Solution litigation, and a declaration that the Company and Federal Insurance Company are obligated to fully indemnify and hold Vital Pharma harmless with respect to the INTERGEL Solution litigation.
The Company believes that Vital Pharma’s and Noetic’s claims have no merit. The Company complied with its obligations under the Supply Agreement. The Company agreed to pay for the costs of Vital Pharma’s defense, subject to a reservation of rights. It is the Company’s understanding that Federal Insurance Company has paid Vital Pharma what Federal believes is the reasonable portion of the legal fees and expenses submitted to it for reimbursement. Although Vital Pharma did complain, during the course of the INTERGEL Solution litigation, that Federal Insurance Company did not pay all of the costs and expenses incurred, Vital Pharma did not provide any basis to challenge the amounts not paid by Federal Insurance Company pursuant to Federal Insurance Company’s bill auditing process. The Company has tendered the defense of this matter to Federal Insurance Company. Federal Insurance Company has agreed, subject to a reservation of rights, to defend the Company. Federal Insurance Company has also agreed to pay any verdict or settlement except to the extent that Vital Pharma is allowed to recover under the Supply Agreement amounts that are deemed “unreasonable” under Federal’s policy.
ETHICON began marketing INTERGEL Solution outside the United States in June 1998 for reducing the incidence of post-surgical adhesions. INTERGEL Solution was approved by the FDA for the U.S. market in November 2001. INTERGEL Solution was voluntarily withdrawn from the market by ETHICON in March 2003 in order to assess information obtained from postmarketing experience with the product, including allegations of adverse events associated with off-label use in non-conservative surgical procedures (such as hysterectomies).
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company’s Common Stock is traded on the NASDAQ Global Market under the symbol LCBM. The following table sets forth for each quarter of fiscal 2007 and 2006 the range of high and low closing sale prices of the Common Stock on the NASDAQ Global Market.
The Company has not paid cash dividends on its Common Stock and does not plan to pay cash dividends in the near future. The Company expects to retain any future earnings to finance the growth of its business.
On August 24, 2007, the Company had 448 shareholders of record.
STOCK PRICE PERFORMANCE GRAPH
The following graph compares the yearly percentage change in the cumulative total shareholder return on the Company’s common stock during the five years ended June 30, 2007 with the cumulative total return on: (i) the Nasdaq Medical Equipment Index and (ii) the Nasdaq Market Index (U.S. Companies). The comparison assumes that $100 was invested on June 30, 2002 in the Company’s common stock and in each of the foregoing indices and assumes reinvestment of dividends.
Item 6.
Item 6. Selected Financial Data
SELECTED CONSOLIDATED FINANCIAL DATA
(In thousands, except per share amounts)
The following sets forth selected historical financial data with respect to the Company and its subsidiaries. The data given below as of and for the five years ended June 30, 2007 has been derived from the Company’s audited Consolidated Financial Statements. Such data should be read in conjunction with the Company’s Consolidated Financial Statements and Notes thereto included elsewhere in this report and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies
The discussion and analysis of the Company’s financial condition and results of operations is based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions in certain circumstances that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the Company’s financial statements. Management bases its estimates and judgments on historical experience, observance of trends in the industry, information provided by customers and other outside sources and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
Revenue Recognition:
The Company’s revenues are recognized when products are shipped to or otherwise accepted by unaffiliated customers pursuant to customers’ orders, the price is defined and collection is reasonably assured. The Securities and Exchange Commission’s Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition” provides guidance on the application of generally accepted accounting principles to selected revenue recognition issues. The Company has concluded that its revenue recognition policy is appropriate and in accordance with generally accepted accounting principles and SAB No. 101.
Allowance for Uncollectible Accounts Receivable:
Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. The Company extends credit to customers in the normal course of business, but generally does not require collateral or any other security to support amounts due. Management performs on-going credit evaluations of its customers and bases the estimated allowance on these evaluations.
Inventories:
Inventories are stated at the lower of cost (first-in, first-out method) or market and have been reduced to the lower of cost or market for obsolete, excess or unmarketable inventory. The lower of cost or market adjustment is based on management’s review of inventories on hand compared to estimated future usage and sales.
Goodwill, Intangible and Other Long-Lived Assets:
Intangible and certain other long-lived assets with a definite life are amortized over their useful lives. Useful lives are based on management’s estimates of the period that the assets will generate revenue.
The Company does not amortize goodwill and reviews goodwill for impairment on a regular basis, at least annually.
Management has reviewed goodwill and other intangibles for impairment and to ensure the propriety of the amortization period and has concluded that such assets are appropriately valued at the financial statement date.
Accounting for Income Taxes:
Income taxes are accounted for under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.” Under this method, deferred tax assets and liabilities are determined based upon the difference between the financial statement and tax bases of assets and liabilities using the enacted tax rates in effect for the year in which the differences are expected to affect taxable income. The tax consequences of events recognized in the current year’s financial statements are included in determining income taxes currently payable. However, because tax laws and financial accounting standards differ in their recognition and measurement of assets, liabilities, equity, revenue, expenses and gains and losses, differences arise between the amount of taxable income and pretax financial income for a year and between the tax bases of assets or liabilities and their reported amounts in the financial statements. Because it is assumed that the reported amounts of assets and liabilities will be recovered and settled, respectively, a difference between the tax basis of an asset or a liability and its reported amount in the balance sheet will result in a taxable or a deductible amount in some future years when the related liabilities are settled or the reported amounts of the assets are recovered, hence giving rise to a deferred tax asset or liability. For deferred tax assets, management assesses the likelihood that the deferred tax assets will be
recovered from future taxable income and to the extent that recovery is not likely, a valuation allowance is established.
In fiscal 2005, management determined that it was appropriate to release a substantial portion of the deferred tax valuation allowance based upon the Company’s then-current and expected level of profitability, and the belief that it was more likely than not that the deferred tax assets would be utilized before they expired. The remaining valuation allowance is provided for foreign net operating losses. As part of the process of preparing the consolidated financial statements, income taxes are required to be estimated. This process involves estimating actual current tax obligations together with assessing temporary differences that may result in deferred tax assets or liabilities. Management judgment is required in determining any valuation allowance recorded against deferred tax assets. Any such valuation allowance would be based on management’s estimates of future taxable income and the period over which deferred tax assets would be recoverable.
Stock-based compensation:
On July 1, 2005, the Company adopted SFAS No. 123(R), “Share-based Payment” (“SFAS 123R”), which requires the fair values of all share-based payment transactions, including grants of stock options, to be recognized in the income statement as an operating expense based on the fair values over the requisite service period. The computation of fair value and the related stock compensation expense involves numerous estimates and assumptions based on historical experience and utilizes valuation models which are designed to produce estimated fair value based on these estimates and assumptions.
Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” - an interpretation of FASB Statement No. 109, “Accounting for Income Taxes” (“FIN 48”), which clarifies the accounting for uncertainty in income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation requires that the Company recognize in the financial statements the impact of a tax position. Recognition is allowed if the tax position is more likely than not to be sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006 with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
In September 2006, the SEC staff issued SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB No. 108 was issued to provide consistency between how registrants quantify financial statement misstatements and is effective for fiscal years ending after November 15, 2006. SAB No. 108 established an approach that requires quantification of financial statement misstatements based on the effects of the misstatement on each of the company’s financial statements and the related financial statement disclosures. This approach is commonly referred to as the “dual approach” because it requires quantification of errors under both the roll-over and iron curtain methods. The initial application of SAB No. 108 did not have a material impact on the Company’s consolidated financial position or results of operations.
In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurement but does not require any new fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company does not expect the impact of this pronouncement to have a material impact on the Company’s consolidated financial position or results of operations.
On February 15, 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB No. 115”. This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. The fair value option established by SFAS No. 159 permits all entities to choose to measure eligible items at fair value at specified election dates. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company does not expect the impact of this pronouncement to have a material impact on the Company’s consolidated financial position or results of operations.
In June 2007, the Financial Accounting Standards Board ratified a consensus opinion reached by the Emerging Issues Task Force (EITF) on EITF Issue 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities.” The guidance in EITF Issue 07-3 requires the Company to defer and capitalize nonrefundable advance payments made for goods or services to be used in research and development activities until the goods have been delivered or the related services have been performed. If the goods are no longer expected to be delivered nor the services expected to be performed, the Company would be required to expense the related capitalized advance payments.
The consensus in EITF Issue 07-3 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2007 and is to be applied prospectively to new contracts entered into on or after December 15, 2007. Early adoption is not permitted. Retrospective application of EITF Issue 07-3 is also not permitted.
The Company intends to adopt EITF Issue 07-3 effective January 1, 2008. The impact of applying this consensus will depend on the terms of the Company’s future research and development contractual arrangements entered into on or after December 15, 2007.
General
The Company manufactures biomaterials and medical devices for use in various surgical markets and provides related specialized contract aseptic manufacturing services. The Company operates through two divisions, the Hyaluronan Division and the Dental Division.
The Company’s Hyaluronan Division is principally involved in the development and manufacture of products utilizing hyaluronan, a naturally occurring polysaccharide that is widely distributed in the extracellar matrix of connective tissues in both animals and humans. In addition, the Company has licensed a sodium hyaluronate cross-linking technology from the CCF designed to provide a development vehicle for a product platform to introduce new products for the existing medical segments, as well as potentially new market segments. Furthermore, we are pursuing other development activities to utilize the Company’s fermentation and aseptic filling capabilities for non-hyaluronan based products.
The Hyaluronan Division primarily sells into three medical segments: 1) Ophthalmic, 2) Orthopedic and 3) Veterinary. Lifecore also supplies hyaluronan to customers pursuing other medical applications, such as aesthetic surgery, medical device coatings, tissue engineering and pharmaceuticals. The Company leverages its hyaluronan manufacturing expertise to provide expanded hyaluronan product offerings and specialized aseptic manufacturing of hyaluronan products.
The Company’s Dental Division develops and markets precision surgical and prosthetic devices for the restoration of damaged or deteriorating dentition and associated support tissues. The Company’s dental implants are permanently implanted in the jaw for tooth replacement therapy as long-term support for crowns, bridges and dentures.
The Dental Division also offers innovative bone regenerative products for the repair of bone defects resulting from periodontal disease and tooth loss. Additionally, the Dental Division provides professional support services to its dental surgery clients through comprehensive education curricula, as provided in the Company’s various Skills Series and Know HOW courses. These professional continuing education programs are designed to train restorative clinicians and their auxiliary teams in the principles of tooth replacement therapy and practice management. The Company’s Increasing Case Acceptance (“ICA”) program offers clients the marketing and consultative tools and training to foster higher patient acceptance of dental implants.
The Dental Division’s products are marketed in the United States through the Company’s direct sales force. Internationally, the Division’s products are marketed through subsidiary direct sales forces in Italy, Germany, France and Sweden, and through 28 national distributors covering 49 additional countries.
Acquisition of Bardo-Biotech SAS
On August 12, 2005, the Company acquired 100% of the stock of Bardo-Biotech SAS, a privately-owned distributor of the Company’s Dental products located in Beauzelle, France. The Company included the operating results of Bardo-Biotech SAS in the financial statements from August 1, 2005, the effective date.
In conjunction with this acquisition, the consideration paid was $401,000 in cash and $362,000 in debt forgiveness. The acquisition resulted in goodwill of $431,000 and intangible assets of $80,000, a portion of which is deductible for tax purposes.
Results of Operations
Year ended June 30, 2007 compared with year ended June 30, 2006.
Net Sales. Net sales increased $6,532,000 or 10% in fiscal 2007 from fiscal 2006. Hyaluronan Division sales increased $1,401,000 or 7%, and Dental Division sales increased $5,131,000 or 12%.
Hyaluronan Division sales increased to $21,552,000 in fiscal 2007 from $20,151,000 in fiscal 2006 due to higher sales to orthopedic and ophthalmic customers and increased revenue from product development activities. Sales of ophthalmic products to Alcon were $8,916,000 in fiscal 2007 compared with $8,306,000 for fiscal 2006.
Dental Division sales increased to $48,077,000 in fiscal 2007 from $42,946,000 in fiscal 2006. Domestic sales increased 11% due to sales of the PRIMA™ Implant System and the addition of sales representatives. International sales increased 13% due to sales of the PRIMA™ Implant System and stronger subsidiary sales. Foreign currency translation comparisons increased fiscal 2007 sales by $790,000 compared to fiscal 2006.
Gross profit. Consolidated gross profit, as a percentage of net sales, was 63% in fiscal 2007 and 62% in fiscal 2006. The gross profit for the Hyaluronan Division increased to 56% in fiscal 2007 from 54% in fiscal 2006. The increase was due to a favorable shift in product mix from lower margin products to higher margin products and increased higher margin product development revenue. Fiscal 2008 Hyaluronan division gross margins are expected to be slightly higher than fiscal 2007 gross margins.
Gross profit for the Dental Division was 66% in fiscal 2007 and 66% in fiscal 2006. Gross margins in the Dental Division are expected to be slightly higher in fiscal 2008, reflecting a consistent product sales mix and increased manufacturing volume.
Research and development. Research and development expenses consist of personnel costs, contract services, facility and equipment charges and materials consumed. Research and development activities include pilot plant operations, development of new formulations, design and testing of new products, regulatory services and clinical evaluation. Research and development expenses increased $816,000 or 21% in fiscal 2007 from fiscal 2006. The increase is due to increases in product development costs and stock-based compensation.
Marketing and sales. Marketing and sales expenses increased by $2,797,000 or 16% in fiscal 2007 from fiscal 2006. The increase was due mainly to the addition of domestic sales representatives, expanded marketing activities and increased expenses at the Company’s French subsidiary.
General and administrative. General and administrative expenses increased by $528,000 or 7% in fiscal 2007 from fiscal 2006. The increase was due to increased subsidiary expenses, increased information systems expenses and an increase in the 401(k) match.
Other income (expense). Net other income, as shown on the Consolidated Statements of Operations, increased $884,000 for fiscal 2007 as compared to fiscal 2006. The increase was due to an increase in interest income of $762,000 resulting from a higher cash balance and higher interest rates in fiscal 2007 and an increase in currency transaction gains realized on Euro-denominated intercompany transactions of $133,000.
Provision (benefit) for income taxes. Provision for income taxes were $4,860,000 or 38.6% for fiscal 2007 compared to $4,380,000 or 38.4% for fiscal 2006. With the exception of the alternative minimum tax and certain state taxes, the Company will not use cash for domestic income taxes until its net operating losses are fully utilized on its tax returns, which is expected to occur in fiscal 2008. The Company believes that in fiscal 2008 its effective rate will be approximately 38.5%, even though the actual amount of taxes paid will be reduced by the utilization of the net operating loss carryforward.
At June 30, 2007, we had approximately $3.3 million and $8.2 million in federal and foreign net operating loss carryforwards, respectively, to reduce future taxable income. The federal carryforwards expire from 2022 through 2025 if not utilized, but are expected to be fully utilized.
At June 30, 2007, the Company had tax credit carryforwards of approximately $1.3 million and $800,000 for federal and state income tax purposes, respectively. The Company expects to utilize its federal and state research and development tax credit carryforwards that would otherwise expire from 2008 through 2027. The federal and state alternative minimum tax credits can be carried forward indefinitely.
Year ended June 30, 2006 compared with year ended June 30, 2005.
Net Sales. Net sales increased $7,402,000 or 13% in fiscal 2006 from fiscal 2005. Hyaluronan Division sales increased $1,623,000 or 9%, and Dental Division sales increased $5,779,000 or 16%.
Hyaluronan Division sales increased to $20,151,000 in fiscal 2006 from $18,528,000 in fiscal 2005 due to higher sales to orthopedic customers and increased revenue from product development offset partially by lower sales of ophthalmic products. Sales of ophthalmic products to Alcon were $8,306,000 in fiscal 2006 compared with $8,697,000 for fiscal 2005.
Dental Division sales increased to $42,946,000 in fiscal 2006 from $37,167,000 in fiscal 2005. Domestic sales increased 22% due to the continued expansion of the Company’s sales representatives, sales of the RENOVA® Internal Hex Implant System and sales from the launch of the PRIMA™ Implant System. Sales in the international markets increased by 8% due to sales from the launch of the PRIMA Implant System and sales from the subsidiary in France, which was acquired in August 2005. Foreign currency translation comparisons decreased fiscal 2006 sales by $422,000 compared to fiscal 2005.
Gross profit. Consolidated gross profit, as a percentage of net sales, was 62% in fiscal 2006 and 60% in fiscal 2005. The gross profit for the Hyaluronan Division increased to 54% in fiscal 2006 from 51% in fiscal 2005; 1.1% of the increase was due to a decrease in unused manufacturing capacity charges associated with increased hyaluronan production and 2.2% of the increase was due to a favorable shift in product mix from lower margin products to higher margin products.
Gross profit for the Dental Division increased to 66% in fiscal 2006 from 64% in fiscal 2005 of which 1.4% was due to a favorable shift in sales mix from lower margin products to higher margin products and .5% was due to reduced discounting.
Research and development. Research and development expenses consist of personnel costs, contract services, facility and equipment charges and materials consumed. Research and development activities include pilot plant operations, development of new formulations, design and testing of new products, regulatory services and clinical evaluation. Research and development expenses decreased $398,000 or 9% in fiscal 2006 from fiscal 2005. The decrease was due to a reduction in fees for consulting and professional services associated with research activity to re-introduce INTERGEL Solution following the market withdrawal in March 2003. Consulting and professional fees associated with INTERGEL Solution were primarily related to the research and study of the products’ clinical results including a detailed analysis of complaints, study of surgical notes and patient charts.
Marketing and sales. Marketing and sales expenses increased by $2,603,000 or 18% in fiscal 2006 from fiscal 2005. The increase was due mainly to costs associated with the launch of the new PRIMA™ implant system, the expansion of the Dental Division’s domestic sales force and international operations (including expenses from the new subsidiary in France) and stock-based compensation expense associated with the adoption of SFAS 123R.
General and administrative. General and administrative expenses increased by $886,000 or 14% in fiscal 2006 from fiscal 2005. The major component of the increase is related to stock-based compensation expense associated with the adoption of SFAS 123R and higher insurance costs.
Other income (expense). Net other income, as shown on the Consolidated Statements of Operations, increased $232,000 for fiscal 2006 as compared to fiscal 2005. The increase was due to a bond retirement expense of $290,000 in the 2005 period and an increase in interest income of $536,000 resulting from a higher cash balance and higher interest rates in fiscal 2006, offset by decreases in currency transaction gains realized on Euro denominated intercompany transactions of $274,000 and the Ethicon, Inc. payment of $250,000 received during the second quarter of fiscal 2005.
Provision (benefit) for income taxes. Provision for income taxes were $4,380,000 or 38.4% for fiscal 2006 compared to a net tax benefit of $9.1 million recorded in fiscal 2005 due to a current tax provision of $2.8 million offset by the release of the valuation allowance against deferred tax assets in the amount of $11.9 million. The release of a substantial portion of the valuation allowance and the resulting recognition of a deferred tax benefit in fiscal 2005 was based on management’s belief that it was more likely than not that these deferred tax assets would be realized due to current and expected profitability. In making this determination, management considered all positive and negative factors. The remaining valuation allowance relates principally to the Company’s foreign net operating loss carryforwards.
The Company’s statement of operations reflected more normal tax charges for fiscal 2006 and beyond. However, with the exception of the alternative minimum tax and certain state taxes, the Company will not use cash for domestic income taxes until its net operating losses are fully realized on its tax returns. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using the enacted tax rates in effect for the year in which the differences are expected to affect taxable income.
At June 30, 2006, we had approximately $15.0 million and $6.3 million in federal and foreign net operating loss carryforwards, respectively, to reduce future taxable income. The federal carryforwards expire from 2010 through 2025 if not utilized, but are expected to be fully utilized.
At June 30, 2006, the Company had tax credit carryforwards of approximately $965,000 and $791,000 for federal and state income tax purposes, respectively. The Company expected to utilize its federal and state research and development tax credit carryforwards that would otherwise expire from 2007 through 2026. The federal and state alternative minimum tax credits can be carried forward indefinitely.
Liquidity and Capital Resources
As of June 30, 2007, the Company had $39.1 million of cash and cash equivalents and working capital of $64.6 million. Cash and cash equivalents increased during the year ended June 30, 2007 by $12.5 million.
Cash Provided by Operating Activities. Operating cash flow in fiscal 2007 was primarily the result of operational profitability. Net cash provided by operations was approximately $12.5 million in fiscal 2007, attributable primarily to net income of $7.7 million and adjustments for non-cash charges related to the changes in deferred tax assets of $3.9 million and depreciation and amortization of $2.3 million. Accounts receivable increased $3.1 million.
Net cash provided by operations in fiscal 2006 was approximately $9.5 million, primarily attributable to net income of $7.0 million and adjustments for non-cash charges related to the changes in deferred tax assets of $3.7 million and depreciation and amortization of $2.0 million. Inventories increased $1.7 million and accounts receivable increased $2.7 million, net of the effects of the acquisition of the France subsidiary.
Net cash provided by operations in fiscal 2005 was approximately $11.1 million, primarily attributable to net income of $17.5 million and adjustments for non-cash charges related to the depreciation and amortization of $2.1 million. Inventory decreased $1.5 million and accounts payable and accrued liabilities increased by $1.1 million, which were partially offset by increases in accounts receivable of $1.6 million.
Cash Used in Investing Activities. Net cash used in investing activities was $2.3 million, $2.3 million, and $1.3 million in fiscal 2007, 2006 and 2005, respectively. Cash used in investing activities reflected purchases of property and equipment of $2.0 million, $2.0 million and $2.0 million in fiscal 2007, 2006 and 2005, respectively. Net cash of $369,000 was used for the license fees and patent costs associated with the technology from CCF. Net cash of $338,000 was used for the acquisition of the stock of the Company’s French distributor in fiscal 2006. In fiscal 2005, a security deposit of $830,000 was returned due to the refinancing of the old industrial revenue bonds.
Cash Provided by Financing Activities. Net cash provided by financing activities was $2,280,000, $976,000 and $156,000 in fiscal 2007, 2006 and 2005, respectively. Cash provided during fiscal 2007 was primarily attributable to proceeds from the exercise of stock options of $2,347,000 offset by payments of $295,000 on the industrial revenue bonds. Cash provided during fiscal 2006 was primarily attributable to proceeds from the exercise of stock options of $1,154,000 offset by payments of $280,000 on the industrial revenue bonds. Cash provided during fiscal 2005 was attributable to proceeds from the exercise of stock options of $768,000 offset by net cash used of $612,000 for the refinancing of the industrial revenue bonds.
The Company has a $5 million credit facility with a bank which has a maturity date of December 31, 2008. The agreement allows for advances against eligible accounts receivable, subject to compliance with covenants. Under the credit facility, interest will accrue at the prime rate minus 1% or LIBOR plus 1.75%, at the Company’s option. At June 30, 2007 and 2006, there were no balances outstanding under the line of credit.
On August 19, 2004, the Company issued variable rate industrial revenue bonds. The proceeds from these bonds were used to retire the existing 10.25% fixed rate industrial revenue bonds on September 1, 2004. The aggregate principal amount of the new bonds was $5,630,000, and the bonds bear interest at a variable rate set weekly by the bond remarketing agent (3.93% as of June 30, 2007). In addition, the Company pays an annual remarketing fee equal to .125% and an annual letter of credit fee of 1.0%. The bonds are collateralized by a bank letter of credit which is secured by a first mortgage on the Company’s facility in Chaska, Minnesota. The terms of the agreement require the Company to comply with various financial covenants including minimum tangible net worth, liabilities to tangible net worth ratio and net income. At June 30, 2007 and 2006, the Company was in compliance with all covenants.
The Company’s ability to generate positive cash flow from operations and sustain its profitability is dependent upon the continued expansion of revenue from its hyaluronan and dental businesses. Growth in the Hyaluronan Division is unpredictable due to the complex governmental regulatory environment for new medical products, difficulty in predicting development timelines when working with customers and the early stage of certain of these markets. Similarly, expansion of the Company’s Dental Division sales is also dependent upon increased
revenue from new and existing customers, successful introduction of new products as well as successfully competing in a more mature market. The Company expects its cash generated from anticipated operations and the availability under the line of credit to satisfy cash flow needs in the near term. No assurance can be given that the Company will maintain positive cash flow from operations. While the Company’s capital resources appear adequate today, the Company may seek additional financing in the future. If additional financing is necessary, no assurance can be given that such financing will be available and, if available, will be on terms favorable to the Company and its shareholders.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements.
Contractual Obligations
Payments due by period for contractual obligations at June 30, 2007 are as follows:
(1)
Long-term debt bears interest at a variable rate set weekly by the bond remarketing agent. A rate of 4.25% was used for the variable portion for the above table. See Note C to the Company’s Consolidated Financial Statements.
Seasonality
The Company’s business is seasonal in nature. Historically, sales in the Dental Division are lower in the first quarter than the rest of the year as a result of European holidays during the summer months.
Cautionary Statement
Except to the extent statements represent historical or current facts, statements included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Form 10-K, in the Letter to Shareholders contained in the Annual Report to Shareholders, in future filings by the Company with the Securities and Exchange Commission and in the Company’s press releases and oral statements made with the approval of authorized executive officers should be considered “forward-looking statements” made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may relate, among other things, to market acceptance and demand for the Company’s products, future product development plans and timing, manufacturing capabilities, availability of raw materials, the results of clinical trials, FDA clearances and the related timing of such, the potential size of the markets for the Company’s products, future product introductions, future revenues and profit margins, expense levels, tax rates and capital needs and the Company’s ability to successfully negotiate acceptable agreements with its corporate partners. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The following important factors, among others, in some cases have affected and in the future could affect the Company’s actual results and could cause its actual financial performance to differ materially from that expressed in any forward-looking statement: (1) obtaining the necessary regulatory approvals for new hyaluronan and dental products; (2) the Company’s reliance on corporate partners to develop new products on a timely basis and to market the Company’s
existing and new hyaluronan products effectively; (3) intense competition in the markets for the Company’s principal products; (4) the uncertainty associated with the future market status of FeHA Solution (formerly labeled as INTERGEL Solution) and (5) other factors discussed under Part I, Item 1A of this Form 10-K. The foregoing list should not be construed as exhaustive, and the Company disclaims any obligation subsequently to revise any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company invests its excess cash in money market mutual funds and bank certificates of deposits. All investments are held to maturity. The market risk on such investments is minimal.
Receivables from sales to foreign customers are denominated in U.S. dollars. Transactions at the Company’s foreign subsidiaries are denominated in European Euros at Lifecore Biomedical SpA, Lifecore Biomedical GmbH and Lifecore Biomedical SAS and are denominated in Swedish Krona at Lifecore Biomedical AB. The Company is exposed to foreign currency exchange rate risk arising from transactions in the normal course of business from sales to its foreign subsidiaries. Because the Company’s products are manufactured or sourced primarily from the United States, a stronger U.S. dollar generally has a negative impact on results from operations outside the United States while a weaker dollar generally has a positive effect. The Company does not use derivative financial instruments to manage foreign currency fluctuation risk.
At June 30, 2007, the Company’s outstanding long-term debt bears interest at a variable rate set weekly by the bond remarketing agent. The effective rate on June 30, 2007 was 3.93%. A ten percent change in this variable rate would be approximately $19,000 annually.
Item 8.
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements and schedule and notes thereto are included on pages through and S-1 of this report and are incorporated herein by reference. Summarized unaudited quarterly financial data for 2007 and 2006 follows:
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective.
Changes in Internal Controls
During the Company’s most recent fiscal quarter, there has been no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Managements Responsibility for Financial Information
Company management is responsible for the preparation and integrity of the consolidated financial statements appearing in the Annual Report. The consolidated financial statements were prepared in conformity with United States generally accepted accounting principles and include amounts based on management’s estimates and judgments. All other financial information in this report has been presented on a basis consistent with the information included in the financial statements.
The Company’s control environment is the foundation for its system of internal controls over financial reporting and is embodied in its Code of Business Conduct and Ethics. It sets the tone of the organization and includes factors such as integrity and ethical values. Internal controls over financial reporting are supported by formal policies and procedures which are reviewed, modified and improved as changes occur in business conditions and operations.
The Audit Committee of the Board of Directors, which is composed solely of outside directors, meets periodically with members of management and the independent registered public accounting firm to review and discuss internal controls over financial reporting and accounting and financial reporting matters. The independent registered public accounting firm reports to the Audit Committee and accordingly has full and free access to the Audit Committee at any time.
Management’s Report on Internal Control over Financial Reporting
Management is also responsible for establishing and maintaining adequate internal control over financial reporting. A system of internal controls is designed to provide and maintain reasonable assurance as to the fair and reliable preparation and presentation of the consolidated financial statements, as well as to safeguard the Company’s assets from unauthorized use or disposition.
Management has conducted an evaluation of the effectiveness of the Company’s internal controls over financial reporting based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. This evaluation included review of the documentation of controls, evaluation of the design effectiveness of controls, testing of the operating effectiveness of the controls and a conclusion on this evaluation. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Based on its evaluation, management has concluded that internal control over financial reporting was effective as of June 30, 2007.
Grant Thornton LLP, an independent registered public accounting firm, has audited our internal control over financial reporting as of June 30, 2007 as stated in their report, which is included herein.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Lifecore Biomedical, Inc.
We have audited Lifecore Biomedical, Inc. and subsidiaries (the Company) Internal Control over Financial Reporting as of June 30, 2007, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting; including the accompanying Item 9A of this Form 10-K. Our responsibility is to express an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Lifecore Biomedical, Inc. and subsidiaries maintained in all material respects effective internal control over financial reporting as of June 30, 2007, based on the criteria established in Internal Control - Integrated Framework issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Lifecore Biomedical, Inc. and subsidiaries as of June 30, 2007 and 2006, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended June 30, 2007 and our report dated September 12, 2007 expressed an unqualified opinion on those financial statements.
/s/ GRANT THORNTON LLP
Minneapolis, Minnesota
September 12, 2007
Item 9B.
Item 9B. Other Information
On May 21, 2007, Benjamin C. Beckham and the Company entered into a separation agreement to set forth the terms and conditions under which Mr. Beckham and the Company terminated his employment relationship. Under the separation agreement, Mr. Beckham is entitled to receive his base salary, less all customary withholding and deductions, for a period of six months beginning on the first pay date after June 4, 2007.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information set forth in the sections entitled “Proposal 1 - Election of Directors,” “Corporate Governance - Board Meetings and Committees” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s Proxy Statement for its 2007 Annual Meeting of Shareholders to be held November 14, 2007, is incorporated herein by reference. See also “Executive Officers of the Registrant” in Item 1 of this report.
The Company has adopted a Code of Business Conduct and Ethics (the “Code”) that applies to all officers, directors and employees. The Code is posted on the Company’s website at www.Lifecore.com under “Investor Info - Corporate Governance”. Any amendments to the Code and waivers of the Code for the Company’s Chief Executive Officer, Chief Financial Officer or Controller will be published on the Company’s website.
Item 11.
Item 11. Executive Compensation
A description of the compensation paid to the Company’s executive officers is set forth in the section entitled “Executive Compensation” of the Company’s Proxy Statement for its 2007 Annual Meeting of Shareholders and, except for the section entitled “Report of the Compensation Committee,” is incorporated herein by reference.
A description of the compensation paid to the Company’s directors is set forth in the section entitled “Corporate Governance - Compensation of Directors” of the Company’s Proxy Statement for its 2007 Annual Meeting of Shareholders, which is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information regarding security ownership of certain beneficial owners and management is set forth in the section entitled “Security Ownership of Certain Beneficial Owners and Management” in the Company’s Proxy Statement for its 2007 Annual Meeting of Shareholders, which is incorporated herein by reference.
Securities authorized for issuance under equity compensation plans
The following table provides information on equity compensation plans under which equity securities of the Company are authorized for issuance as of June 30, 2007:
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Descriptions of the independence of the Company’s directors and the Board’s policy on approval of related person transactions are set forth in “Corporate Governance - Board Independence,” “Corporate Governance - Board Meetings and Committees” and “Corporate Governance - Related Person Transaction Approval Policy” and are incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services
A description of the fees paid to the Company’s independent registered public accounting firm is set forth in the sections entitled “Audit Fees, Audit-Related Fees, Tax Fees and All Other Fees” and “Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services Provided by the Company’s Independent Registered Public Accounting Firm” of the Company’s Proxy Statement for its 2007 Annual Meeting of Shareholders and are incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
Documents filed as part of the report:
+
Pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended, confidential portions of these exhibits have been deleted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment.
*
Denotes management contract or compensatory plan, contract or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
LIFECORE BIOMEDICAL, INC.
Dated: September 13, 2007 /s/ Dennis j. allingham
Dennis J. Allingham
President, Chief Executive Officer and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in capacities and on the dates indicated.
Exhibit Index
+
Pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended, confidential portions of these exhibits have been deleted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment.
*
Denotes management contract or compensatory plan, contract or arrangement.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Lifecore Biomedical, Inc.
We have audited the accompanying consolidated balance sheets of Lifecore Biomedical, Inc. and subsidiaries as of June 30, 2007 and 2006, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended June 30, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Lifecore Biomedical, Inc. and subsidiaries as of June 30, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2007, in conformity with accounting principles generally accepted in the United States of America.
Our audits were conducted for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The accompanying Schedule II of Lifecore Biomedical, Inc. and subsidiaries is presented for purposes of additional analysis and is not a required part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements for each of the three years in the period ended June 30, 2007 and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of June 30, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated September 12, 2007 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ GRANT THORNTON LLP
Minneapolis, Minnesota
September 12, 2007
Lifecore Biomedical, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
June 30,
Lifecore Biomedical, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS - (continued)
June 30,
The accompanying notes are an integral part of these statements.
Lifecore Biomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended June 30,
The accompanying notes are an integral part of these statements.
Lifecore Biomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
The accompanying notes are an integral part of these statements.
Lifecore Biomedical, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended June 30,
The accompanying notes are an integral part of these statements.
Lifecore Biomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Lifecore Biomedical, Inc. (the “Company”) manufactures biomaterials and surgical devices for use in various surgical markets and provides specialized contract aseptic manufacturing services through its two divisions, the Hyaluronan Division and the Dental Division. The Company’s manufacturing facility is located in Chaska, Minnesota. The Hyaluronan Division markets its products through original equipment manufacturers and contract manufacturing alliances in ophthalmologic and orthopedic surgery and veterinary medicine. The Dental Division markets its products through direct sales in the United States, Italy, Germany, France and Sweden and through distributors in other foreign countries.
In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting periods. Actual results could differ from those estimates.
A summary of significant accounting policies consistently applied in the preparation of the financial statements follows:
1. Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
2. Cash and Cash Equivalents
The Company considers all highly liquid temporary investments with original maturities of three months or less to be cash equivalents. At June 30, 2007 and 2006, substantially all of the Company’s cash and cash equivalents were invested in money market funds and bank certificates of deposit. Bank balances held at our foreign subsidiaries were $825,000 and $668,000 at June 30, 2007 and 2006, respectively.
3. Accounts Receivable
The Company extends credit to customers in the normal course of business but generally does not require collateral or any other security to support amounts due. Management performs on-going credit evaluations of its customers. The Company’s customers are located primarily throughout the United States, Asia, Europe and South America. Accounts receivable balances from customers located in Asia, Europe and South America were 13%, 32% and 8% of total receivables, respectively, at June 30, 2007 and 11%, 34% and 10% of total receivables, respectively, at June 30, 2006. The Company maintains allowances for potential credit losses, which were $534,000 and $505,000 at June 30, 2007 and 2006, respectively. The allowance is based on history, economic conditions, and composition of its aging and in some cases, makes allowances for specific customers based on these and other factors.
Lifecore Biomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
4. Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or market. Inventories consist mainly of finished hyaluronan powder, aseptic units and dental products and related raw materials. The Company’s inventory has been reduced to lower of cost or market for obsolete, excess or unmarketable inventory. The lower of cost or market adjustment is based on management’s review of inventories on hand compared to estimated future usage and sales. The portion of finished hyaluronan powder inventory not expected to be consumed within the next 12 months is classified as a long-term asset. The finished hyaluronan inventory is maintained in a frozen state and has a shelf life of ten years. Inventories consist of the following:
5. Depreciation
Depreciation is provided in amounts sufficient to charge the cost of depreciable assets to operations over their estimated service lives principally on a straight-line method for financial reporting purposes and on straight-line and accelerated methods for income tax reporting purposes. Depreciation expense was approximately $2,139,000, $1,927,000 and $2,011,000 for the years ended June 30, 2007, 2006 and 2005, respectively. Lives used in straight-line depreciation for financial reporting purposes are as follows:
6. Intangibles
Intangibles consist primarily of the cost of goodwill related to acquisitions, patents and distribution rights and licenses.
Also included within intangibles are costs incurred to register patents and trademarks, which are capitalized as incurred. Amortization of these costs commences when the related patent or trademark is granted. The costs are amortized over the estimated useful life of the patent or trademark.
Lifecore Biomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
Goodwill is tested for impairment on an annual basis, or when there is an indication that an impairment has occurred, and is written down when impaired by applying a fair-value based test. Purchased intangible assets other than goodwill are amortized over their estimated useful lives on a straight-line basis unless these lives are determined to be indefinite. There was no impairment recorded in fiscal years 2007 and 2006.
Intangibles consisted of the following at June 30:
7. Revenue Recognition
The Company recognizes revenue when product is shipped, or otherwise accepted by the customer, pursuant to customers’ orders, the price is fixed and collection is reasonably assured.
8. Shipping & Handling
Costs incurred with the shipment of product between the Company and its vendors are classified as cost of goods sold.
Costs incurred with the shipment of products from the Company to its customers are classified in net sales when billed to the customer.
9. Income taxes
Deferred income taxes are provided on the liability method whereby deferred tax assets and deferred tax liabilities are recognized for the effects of taxable temporary differences. Temporary differences are the differences between reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
10. Comprehensive Income
Comprehensive income generally represents all changes in stockholders’ equity except those resulting from transactions with stockholders. The Company’s translation adjustments represent the components of comprehensive income that are excluded from net income.
Lifecore Biomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
11. Net Income Per Common Share
The Company’s basic net income per share amounts have been computed by dividing net income by the weighted average number of outstanding common shares. The Company’s diluted net income per share is computed by dividing net income by the weighted average number of outstanding common shares and common share equivalents relating to stock options, when dilutive. For the fiscal years ended June 30, 2007, 2006, and 2005, 461,666, 412,241 and 369,912 shares of common stock equivalents, respectively, were included in the computation of diluted net income per share.
Options to purchase 114,000, 524,168 and 479,418 shares of common stock with a weighted average exercise price of $18.85, $16.24 and $16.23 were outstanding at June 30, 2007, 2006, and 2005, respectively, but were excluded from the computation of common share equivalents because their exercise prices were greater than the average market price of the common shares.
12. Stock-Based Compensation
Commencing July 1, 2005, the Company adopted Statement of Financial Accounting Standard No. 123R, “Share-Based Payment” (“SFAS 123R”), which requires all share-based payments, including grants of stock options, to be recognized in the income statement as an operating expense based on their fair values over the requisite service period.
The Company recognized stock-based compensation expense related to employee and non-employee director options as follows:
The Company classifies stock option expense based on the option holders’ salary expense classification.
As of June 30, 2007, $1,213,000 of unrecognized compensation costs related to non-vested awards was expected to be recognized over a weighted average period of approximately 1.8 years. The total fair value of shares vested during the years ended June 30, 2007, 2006, and 2005, was $1,035,000, $629,000 and $1,871,000, respectively.
Lifecore Biomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
Prior to adopting SFAS 123R, the Company accounted for stock-based compensation under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” The Company applied the modified prospective method in adopting SFAS 123R. Accordingly, periods prior to adoption have not been restated. The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to the comparable periods in the prior fiscal year.
The weighted average fair value of options granted in 2007, 2006 and 2005 was $8.50, $7.94 and $4.94 per share, respectively. The total intrinsic value of options exercised during the years ended June 30, 2007, 2006 and 2005, was $1,706,000, $742,000 and $679,000, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used:
The expected life of the options is based on evaluations of historical and expected future employee exercise behavior. The risk-free interest rate is based on the U.S. Treasury rates at the date of grant with maturity dates approximately equal to the expected life at the grant date. Volatility is based on historical volatility of the Company’s stock, which was adjusted for two identifiable periods of unusual volatility, due to events not expected to reoccur. The Company has not historically issued any dividends and does not expect to in the foreseeable future.
13. Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” - an interpretation of FASB Statement No. 109, “Accounting for Income Taxes” (“FIN 48”), which clarifies the accounting for uncertainty in income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation requires that the Company recognize in the financial statements the impact of a tax position. Recognition is allowed if the tax position is more likely than not to be sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006 with the cumulative effect of the change in accounting
Lifecore Biomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (continued)
principle recorded as an adjustment to opening retained earnings. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial position or results of operations.
In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 was issued to provide consistency between how registrants quantify financial statement misstatements and is effective for fiscal years ending after November 15, 2006. SAB 108 established an approach that requires quantification of financial statement misstatements based on the effects of the misstatement on each of the company’s financial statements and the related financial statement disclosures. This approach is commonly referred to as the “dual approach” because it requires quantification of errors under both the roll-over and iron curtain methods. The initial application of SAB 108 did not have a material impact on the Company’s consolidated financial position or results of operations.
In September 2006, the Financial Accounting Standards Board issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurement but does not require any new fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company does not expect the impact of this pronouncement to have a material impact on the Company’s consolidated financial position or results of operations.
On February 15, 2007, the Financial Accounting Standards Board issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB No. 115. This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. The fair value option established by SFAS No. 159 permits all entities to choose to measure eligible items at fair value at specified election dates. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company does not expect the impact of this pronouncement to have a material impact on the Company’s consolidated financial position or results of operations.
In June 2007, the Financial Accounting Standards Board ratified a consensus opinion reached by the Emerging Issues Task Force (EITF) on EITF Issue 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services Received for Use in Future Research and Development Activities.” The guidance in EITF Issue 07-3 requires the Company to defer and capitalize nonrefundable advance payments made for goods or services to be used in research and development activities until the goods have been delivered or the related services have been performed. If the goods are no longer expected to be delivered nor the services expected to be performed, the Company would be required to expense the related capitalized advance payments.
The consensus in EITF Issue 07-3 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2007 and is to be applied prospectively to new contracts entered into on or after December 15, 2007. Early adoption is not permitted. Retrospective application of EITF Issue 07-3 is also not permitted.
The Company intends to adopt EITF Issue 07-3 effective January 1, 2008. The impact of applying this consensus will depend on the terms of the Company’s future research and development contractual arrangements entered into on or after December 15, 2007.
Lifecore Biomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
NOTE B - LINE OF CREDIT
The Company has a $5,000,000 credit facility with a bank which has a maturity date of December 31, 2008. The agreement allows for advances against eligible accounts receivable, subject to compliance with covenants. Under the credit facility, interest will accrue at the prime rate minus 1% or LIBOR plus 1.75%, at the Company’s option. At June 30, 2007 and 2006, there were no balances outstanding under the line of credit.
NOTE C - LONG-TERM OBLIGATIONS
On August 19, 2004, the Company issued variable rate industrial revenue bonds. The proceeds from these bonds were used to retire the then existing 10.25% fixed rate industrial revenue bonds on September 1, 2004. The aggregate principal amount of the new bonds was $5,630,000, and the bonds bear interest at a variable rate set weekly by the bond remarketing agent (3.93% and 4.17% on June 30, 2007 and 2006). The bonds are collateralized by a bank letter of credit which is secured by a first mortgage on the Company’s facility in Chaska, Minnesota. The terms of the agreement require the Company to comply with various financial covenants including minimum tangible net worth, liabilities to tangible net worth ratio and net income. In addition, the Company pays an annual remarketing fee equal to .125% and an annual letter of credit fee of 1.0%. As a result of calling the fixed rate bonds for redemption, the Company incurred an early redemption premium of approximately $120,000 and wrote off unamortized deferred financing costs of approximately $170,000, both of which were recorded in the first quarter of fiscal 2005.
Deferred financing costs associated with the newly issued bonds of approximately $196,000 are being amortized over the life of the new bonds, which are scheduled to be fully repaid in 2020.
Long-term obligations consist of the following:
The aggregate minimum annual principal payments of long-term obligations for the years ending June 30 are as follows:
Lifecore Biomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
NOTE D - INCOME TAXES
The provision (benefit) for income taxes consists of the following at June 30:
Deferred tax assets and liabilities represent the tax effects, based on current tax law, of future deductible or taxable amounts attributable to events that have been recognized in the financial statements. Deferred tax assets (liabilities) consist of the following at June 30:
Lifecore Biomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
NOTE D - INCOME TAXES - (continued)
Management periodically evaluates the recoverability of the deferred tax assets and recognizes the tax benefit only as reassessment demonstrates that they are realizable. At such time, if it is determined that it is more likely than not that the deferred tax assets are realizable, the valuation allowance will be adjusted. At June 30, 2004, the Company provided a valuation allowance against its deferred tax assets due to the uncertainty regarding their realizability. During the fourth quarter of 2005, the Company determined it is more likely than not that a portion of these deferred tax assets will be realized and released $12.6 million of the valuation allowance related to domestic deferred tax assets. Of the $12.6 million, $11.9 million was recorded as a benefit related to the release of the beginning of the year valuation allowance. The remaining $697,000 was added to additional paid in capital to reflect the tax difference related to stock options.
The valuation allowance at June 30, 2007 and 2006 relates to the Company’s foreign net operating loss carryforwards. The Company operates in several countries and is subject to various tax regulations and tax rates. The provisions for income taxes are computed based on income reported for financial statement purposes in accordance with the tax rules and regulations of the taxing authorities where the income is earned. Because the foreign subsidiaries purchase the majority of their goods from the U.S. parent company at market prices, the income (loss) before income taxes at the foreign subsidiaries includes intercompany gross profits paid to the U.S. parent company. These intercompany profits are eliminated in the consolidated results. Income (loss) before income taxes for the foreign operations were $(827,000), $(1,694,000) and $(1,377,000) for the years ended June 30, 2007, 2006 and 2005, respectively.
At June 30, 2007, the Company had approximately $3.3 million and $8.2 million in federal and foreign net operating loss carryforwards, respectively, to reduce future taxable income. The federal carryforwards expire from 2022 through 2025, but are expected to be fully utilized. There are no material limitations on the foreign net operating loss carryforwards.
At June 30, 2007 the Company had tax credit carryforwards of approximately $1.3 million and $800,000 for federal and state income tax purposes, respectively. The Company expects to utilize its federal and state research and development tax credit carryforwards that would otherwise expire from 2008 through 2027. The federal and state Alternative Minimum Tax credits can be carried forward indefinitely.
In October 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into law by the President. Among other provisions, the Act provides for a phase-out of the extraterritorial income exclusion deduction. During fiscal 2007, the Company had a $402,000 tax benefit from this deduction. This deduction will phase out during fiscal 2006 and 2007. However, the Act provides a new deduction for domestic manufacturing activity. The Company will not benefit from this deduction until all domestic net operating losses have been utilized. In addition, the Act contains other benefits which are not expected to have a significant impact on the Company.
Lifecore Biomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
NOTE D - INCOME TAXES - (continued)
Differences between income tax expense (benefit) and amounts derived by applying the statutory federal income tax rate to income before income taxes are as follows for fiscal years ending June 30:
NOTE E - SHAREHOLDERS’ EQUITY
Stock Options
The Company has three stock option plans. The Company’s stock options generally vest ratably over four years of service and have a contractual life of 10 years. The Company has authorized 5,000,000 shares for grant under the 1990, 1996 and 2003 Stock Option Plans. Options will be granted under all plans at exercise prices that are determined by a committee appointed by the Board of Directors. Options granted to date under all plans have been at exercise prices equal to the fair market value of the Company’s stock on the date of grant. Each grant awarded specifies the period for which the options are exercisable and provides that the options shall expire at the end of such period.
Option transactions under the 1990 and 1996 Stock Option Plans during the three years ended June 30, 2007 are summarized as follows (no stock options have been granted under the 2003 Plan):
Lifecore Biomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
NOTE E - SHAREHOLDERS’ EQUITY - (continued)
The following table summarizes information concerning currently outstanding stock options:
On June 16, 2005 the Company accelerated the vesting of 74,375 stock options which had an exercise price greater than the closing price on that date. The accelerated vesting enabled the Company to avoid recognizing in its income statement compensation expense associated with these options in future periods upon the adoption by the Company of FASB Statement No. 123R in July 2005.
Restricted Stock Awards
During fiscal 2005, the Company granted 60,000 restricted common stock awards to its officers. The restricted shares awarded in fiscal 2005 will vest at the earlier of four years from the date of issuance or upon achievement of financial performance criteria for the fiscal years 2005, 2006 and 2007. During fiscal 2006, the Company granted 7,000 restricted common stock awards to a new officer at a price of $15.99 and 1,203 restricted common stock awards to two of the Company’s non-employee directors at a price of $14.95. The restricted shares awarded in fiscal 2006 will vest at the earlier of three years from the date of issuance or upon achievement of financial performance criteria for fiscal years 2006 and 2007. The restricted shares awarded in fiscal 2006 to the two non-employee directors were fully vested in fiscal 2006. During fiscal 2007, the Company granted 3,500 restricted common stock awards to a new officer at a price of $15.91 and 742 restricted common stock awards to one of the Company’s non-employee directors at a price of $16.16. The restricted shares awarded in fiscal 2007 will vest at the earlier of two years from the date of issuance or upon achievement of financial performance criteria for fiscal year 2007. The restricted shares awarded in fiscal 2007 to the non-employee directors were fully vested in fiscal 2007. The employee forfeits unvested shares upon the termination of employment prior to the end of the
Lifecore Biomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
NOTE E - SHAREHOLDERS’ EQUITY - (continued)
vesting period. The Company achieved the financial performance criteria in fiscal 2007. Stock compensation expense recognized related to these grants totaled $230,000, $226,000 and $191,000 during the fiscal years ended June 30, 2007, 2006 and 2005, respectively.
Restricted stock activities during the three years ended June 30, 2007 are summarized as follows:
Shareholder Rights Plan
In May 1996 the Board of Directors unanimously adopted a shareholder rights plan designed to ensure that all of the Company’s shareholders receive fair and equal treatment in the event of any proposal to acquire the Company. The rights expired on June 15, 2006.
NOTE F - COMMITMENTS AND CONTINGENCIES
Royalty Agreements
The Company has entered into agreements that provide for royalty payments based on a percentage of net sales of certain products. Royalty expense under these agreements was $272,000, $315,000 and $291,000 for the years ended June 30, 2007, 2006 and 2005, respectively.
Severance Agreements
The Company has an agreement with each officer that provides severance pay benefits if there is a change in control of the Company (as defined) and the officer is involuntarily terminated (as defined). The maximum potential liability under these agreements at June 30, 2007 was approximately $1,211,000.
Legal Proceedings
Lifecore has been named as a defendant in 81 product liability lawsuits. The lawsuits alleged that the plaintiffs suffered injuries due to the defective nature of GYNECARE INTERGEL Adhesion Prevention Solution (“INTERGEL Solution”) which was manufactured by Lifecore and marketed by ETHICON, Inc (“ETHICON”). The other defendants in these lawsuits were ETHICON, which was Lifecore’s exclusive worldwide marketing partner for INTERGEL Solution through its division, GYNECARE Worldwide, and Johnson & Johnson, the parent company of ETHICON. Many of the lawsuits also named Vital Pharma, Inc. (“Vital Pharma”) as a defendant; Vital Pharma acted as the contract packager for the INTERGEL Solution. The plaintiffs in these actions were individuals who
Lifecore Biomedical, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
NOTE F - COMMITMENTS AND CONTINGENCIES - (continued)
were patients in medical procedures during which INTERGEL Solution was used and who were allegedly injured due to the defective nature of INTERGEL Solution.
ETHICON accepted Lifecore’s tender of the defense of these lawsuits under the Conveyance, License, Development and Supply Agreement between the parties, subject to a reservation of rights, and ETHICON defended Lifecore in all of these matters. Lifecore accepted Vital Pharma’s tender of the defense of these lawsuits under the Supply Agreement between Lifecore and Vital Pharma, subject to a reservation of rights. Lifecore’s insurer, Federal Insurance, has paid for Vital Pharma’s defense. Lifecore has also asserted that ETHICON is obligated to pay for Vital Pharma’s defense costs, pursuant to the agreement between ETHICON and Lifecore.
On September 20, 2006, settlement documents relating to all but one of the lawsuits remaining at that date were executed on behalf of the parties. The terms of the settlement do not call for any cash payment by Lifecore. Since the execution of the settlement documents, Lifecore has been sued in two additional lawsuits, one filed in Nebraska and one in Colorado, and the one remaining lawsuit from the original 81 has been settled.
On September 25, 2006, Vital Pharma and its insurer, Noetic Specialty Insurance Company (“Noetic”), sued the Company and its insurer, Federal Insurance Company. It is the Company’s understanding that Federal Insurance Company has paid Vital Pharma what Federal believes is the reasonable portion of the legal fees and expenses submitted to it for reimbursement. Vital Pharma and Noetic are seeking reimbursement of all of the legal fees and expenses incurred in the INTERGEL Solution litigation and a declaration that the Company and Federal Insurance Company are obligated to fully indemnify and hold Vital Pharma harmless with respect to the INTERGEL Solution litigation. The Company believes that Vital Pharma’s and Noetic’s claims have no merit.
License Agreement
The Company has entered into a world-wide exclusive license and development agreement with the Cleveland Clinic Foundation to develop and commercialize hyaluronan-based products and related applications. The license is for patented hyaluronan-based cross-linking technology that can be used for products in aesthetics, orthopedics, ophthalmology and other medical fields. Under the terms of this agreement, the Company is committed to providing $325,000 of research funding in each of the next two years related to the development of this technology.
NOTE G - EMPLOYEE BENEFIT PLAN
The Company has a 401(k) profit sharing plan for eligible employees. The Company, at the discretion of the Board of Directors, may set a matching percentage that is proportionate to the amount of the employees’ elective contributions each year. During the years ended June 30, 2007, 2006 and 2005, the Board of Directors authorized a company matching contribution to the plan of $234,000, $242,000 and $93,000, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
NOTE H - SEGMENT INFORMATION
The Company operates two business segments. The Hyaluronan Division manufactures, markets and sells products containing hyaluronan and provides contract aseptic packaging services. The Dental Division produces and markets various dental products in the area of implant dentistry. Currently, products containing hyaluronan are sold primarily to customers pursuant to supply agreements. Sales to Alcon under such agreements were 13%, 13% and 16% of total consolidated sales in 2007, 2006 and 2005, respectively. The Company’s Dental Division markets products directly to clinicians and dental laboratories in the United States, Italy, Germany, France and Sweden and primarily through distributorship arrangements in other foreign locations. Sales to customers located principally in Europe accounted for 39%, 37% and 39% of total consolidated sales during the years ended June 30, 2007, 2006 and 2005, respectively.
Segment information for the Company is as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
NOTE I - ACQUISITION OF BARDO-BIOTECH SAS
On August 12, 2005, the Company acquired 100% of the stock of Bardo-Biotech SAS, a privately-owned distributor of the Company’s Dental products located in Beauzelle, France. The Company included the operating results of Bardo-Biotech SAS in the financial statements from August 1, 2005, the effective date.
In conjunction with this acquisition, the consideration included was $401,000 in cash and $362,000 in debt forgiveness. The acquisition resulted in goodwill of $431,000 and intangible assets of $80,000, a portion of which is deductible for tax purposes.
NOTE J - AGREEMENTS
On September 20, 2004, the Company secured worldwide marketing rights to its ferric hyaluronan adhesion prevention product from Ethicon, Inc. Lifecore’s product, which was previously marketed by Gynecare, a division of Ethicon, Inc. (“Gynecare”), under the trademark GYNECARE INTERGEL* Adhesion Prevention Solution, was voluntarily withdrawn from the market by Gynecare on March 27, 2003 to assess information obtained from its usage in the treatment of patients. Under the agreement, Gynecare will have no responsibility for any aspect of the future manufacture, marketing, sale or distribution of the product nor will it derive any financial benefit therefrom. A payment of $250,000, included in other income, was received during the second quarter of fiscal year 2005 from Ethicon, Inc. in conjunction with the above mentioned agreement.
NOTE K - RECLASSIFICATIONS
Certain 2006 and 2005 amounts have been reclassified to conform to the 2007 presentation.
Lifecore Biomedical, Inc. and Subsidiaries
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(A)
Deductions represent accounts receivable balances written-off during the year.
S-1