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BUSINESS ACQUISITIONS AND DIVESTITURE | 6 Months Ended
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Jun. 30, 2018
Business Combinations [Abstract] |
BUSINESS ACQUISITIONS AND DIVESTITURE | BUSINESS ACQUISITIONS AND DIVESTITURE Johnson & Johnson's Codman Neurosurgery Business On October 2, 2017, upon the terms and subject to the conditions set forth in the asset purchase agreement entered into by the Company with DePuy Synthes, Inc., a Delaware corporation (“DePuy Synthes”), a wholly owned subsidiary of Johnson & Johnson (the "Purchase Agreement"), the Company completed the acquisition of certain assets, and assumed certain liabilities, of Johnson & Johnson’s Codman neurosurgery business (the "Codman Acquisition"). Under the terms of the Purchase Agreement, the Company paid an aggregate purchase price of $1.014 billion, subject to adjustments set forth in the Purchase Agreement relating to the book value of inventory transferred to the Company at the closing of the Codman Acquisition. The book value of certain inventory retained by DePuy Synthes will be transferred to the Company in the future along with certain prepaid taxes. The Codman Acquisition was accounted for using the acquisition method of business combination under ASC 805, Business Combinations. The Company recorded revenue for Codman Neurosurgery of approximately $79.2 million and $157.1 million, in the condensed consolidated statements of operations and comprehensive income for the three and six months ended June 30, 2018. The net income or loss attributable to this acquisition cannot be identified on a stand-alone basis because it is in the process of being integrated into the Company's operations. The following summarizes the preliminary allocation of the purchase price based on the fair value of the assets acquired and liabilities assumed:
| Preliminary Purchase Price Allocation |  | Weighted Average Life
| (Dollars in thousands) |  |
Inventory | $ | 74,962 |  |  |
Assets held for sale | 30,813 |  |  |
Other current assets | 8,202 |  |  |
Property, plant and equipment | 35,949 |  |  |
Intangible assets: |  |  |
Codman corporate trade name | 162,900 |  |  | Indefinite
Completed technology | 379,900 |  |  | 22 years
Goodwill | 343,012 |  |  |
Total assets acquired | 1,035,738 |  |  |
Accrued expenses | 1,730 |  |  |
Pension liabilities | 19,917 |  |  |
Net assets acquired | $ | 1,014,091 |  |  |
During the first six months of 2018, the Company adjusted its preliminary purchase price allocation of goodwill by $3.2 million because of working capital adjustments of $6.2 million that were offset by inventory adjustments of $3.0 million when the Company obtained additional information about the acquired assets. During the first quarter of 2018, the Company received cash of $5.7 million from Depuy Synthes related to working capital adjustments, which was recorded within investing activities on the consolidated statements of cash flows. During the second quarter of 2018, the Company received an additional $21.0 million related to working capital adjustments. During the first half of 2018, the Company paid $15.9 million for inventory that was included in the initial purchase price allocation. The payment was included within financing activities on the consolidated statements of cash flows. The Company recorded $3.0 million and $14.5 million in cost of goods sold related to fair value inventory purchase accounting adjustments for the three and six months ended June 30, 2018. As of June 30, 2018, certain amounts relating to the valuation of property, plant and equipment have not been finalized. The finalization of these matters may result in changes to goodwill. Goodwill related to the Codman Acquisition was allocated to the Codman Specialty Surgical segment. Goodwill is the excess of the consideration transferred over the net assets recognized and represents the expected revenue and cost synergies of the combined company and assembled workforce. Goodwill recognized as a result of the acquisition is generally deductible for income tax purposes. In the fourth quarter of 2017, the Company wrote-off construction in progress of $6.3 million related to a project acquired as part of the Codman Acquisition that the Company decided to discontinue after the acquisition. Divestiture to Natus On September 8, 2017, to facilitate the acquisition of the Codman Neurosurgery Business and to comply with legal requirements, the Company and certain of its subsidiaries entered into an asset purchase agreement (the “Divestiture Agreement”) with Natus Medical Incorporated (“Natus”), pursuant to which the Company agreed to divest its global Camino® Intracranial Pressure monitoring product lines and the U.S. rights to its fixed pressure shunts business within its Codman Specialty Surgical segment together with certain neurosurgery assets acquired as part of the Codman Acquisition, which includes Codman U.S. dural graft implant, external ventricular drainage catheter and cerebrospinal fluid collection systems businesses (the “Divestiture”). The Divestiture Agreement was entered into in connection with the review of the Codman Acquisition by the Federal Trade Commission and the antitrust authority of Spain. On October 6, 2017, upon the terms and subject to the conditions of the Divestiture Agreement, the Divestiture was completed and Natus paid an aggregate purchase price of $46.4 million. Assets and liabilities divested consisted of the following as of October 6, 2017 (amounts in thousands):
Inventories | $ | 8,348 |
Prepaid expenses and other current assets | 36 |
Assets held for sale | 30,813 |
Property, plant and equipment, net | 1,122 |
Goodwill | 2,861 |
Total assets divested | $ | 43,180 |
Deferred revenue | $ | 1,082 |
Accrued compensation | 209 |
Total liabilities divested | $ | 1,291 |
Assets held for sale includes assets and liabilities related to the U.S. dural graft implant, external ventricular drainage catheters and cerebrospinal fluid collection systems businesses acquired as part of the Codman Acquisition. The transitional supply agreement with Natus requires the Company to provide to Natus certain assets defined in the transitional supply agreement upon termination. The Company recognized a liability of $1.3 million, included in other liabilities in the consolidated balance sheet, related to estimated cost of assets to be provided to Natus upon termination of the transitional supply agreement. The Divestiture does not represent a strategic shift that will have a major effect on the Company's operations and financial statements. Goodwill was allocated to the assets and liabilities divested using the relative fair value method. The Company recognized a pretax gain on sale of business of $2.6 million included in other income, net in its consolidated statement of operations for the year ended December 31, 2017. Derma Sciences On February 24, 2017, the Company executed the Agreement and Plan of Merger (the "Merger Agreement") under which the Company acquired all of the outstanding shares of Derma Sciences, Inc., a Delaware corporation ("Derma Sciences") for an aggregate purchase price of approximately $210.8 million, including payment of certain of Derma Sciences' closing expenses and settlement of stock-based compensation plans of $4.8 million and $4.3 million, respectively. The purchase price consisted of a cash payment to the former stockholders of Derma Sciences of approximately $201.7 million upon the closing of the transaction. Derma Sciences is a tissue regeneration company focused on advanced wound and burn care that offers products to help manage chronic and hard-to-heal wounds, especially those resulting from diabetes and poor vascular functioning. The revenue and the net income or loss attributable to this acquisition cannot be identified on a stand-alone basis because it has been integrated into the Company's operations. The following summarizes the allocation of the purchase price based on the fair value of the assets acquired and liabilities assumed:
| Purchase Price Allocation |
| (Dollars in thousands) |
Cash and cash equivalents | $ | 16,512 |  |
Short-term investments | 19,238 |  |
Accounts receivable | 8,949 |  |
Inventory | 17,977 |  |
Prepaid expenses and other current assets | 4,369 |  |
Property, plant and equipment | 4,311 |  |
Intangible assets: |  | Wtd. Avg. Life:
Customer relationship | 78,300 |  | 14 years
Trademarks/brand names | 13,500 |  | 15 years
Completed technology | 11,600 |  | 14 years
Non-compete agreement | 280 |  | 1 year
Goodwill | 73,765 |  |
Deferred tax assets | 14,524 |  |
Other assets | 101 |  |
Total assets acquired | 263,426 |  |
Accounts payable | 4,560 |  |
Accrued expenses and other current liabilities | 7,409 |  |
Contingent liability | 37,174 |  |
Other liabilities | 3,805 |  |
Net assets acquired | $ | 210,478 |  |
Goodwill related to the Derma Sciences acquisition was allocated to the Orthopedics and Tissue Technologies segment. Goodwill is the excess of the consideration transferred over the net assets recognized and represents the expected revenue and cost synergies of the combined company and assembled workforce. Goodwill recognized as a result of the acquisition is not deductible for income tax purposes. Short-term Investments Short-term investments recognized at the acquisition date of Derma Sciences are investments in equity and debt securities including certificates of deposit purchased with an original maturity greater than three months which are deposited in various U.S. financial institutions and are fully insured by the Federal Deposit Insurance Corporation. The Company considers securities with original maturities of greater than 90 days to be available for sale securities. Securities under this classification are recorded at fair value and unrealized gains and losses are recorded within accumulated other comprehensive income. The estimated fair value of the available for sale securities is determined based on quoted market prices. The Company evaluates securities with unrealized losses to determine whether such losses, if any, are other than temporary. Short-term investments are classified as Level 1 in fair value hierarchy. Fair values of short-term investments are determined using the unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the balance sheet date. In the second quarter of 2017, the Company sold the acquired short-term investments and recognized a loss of $2.3 million included in other income (expense), net in the consolidated statement of operations. Deferred Taxes The acquired deferred taxes of $14.5 million include a deferred tax asset of $39.7 million related to a federal net operating loss which the Company expects to utilize against income in future periods and a deferred tax asset of $16.4 million related to intangibles acquired by Derma Sciences in previous periods, offset by a deferred tax liability of $41.1 million for new intangibles for which the Company will not receive a tax benefit and a deferred tax liability of $0.5 million related to various deferred items. In the second quarter of 2017, the Company decreased the preliminary estimated value of this deferred tax liability by $1.5 million to reflect the adjustments to preliminary estimated fair values of assets and liabilities acquired. In the fourth quarter of 2017, the Company decreased the preliminary value of the deferred tax asset by $3.3 million to reflect returns filed for periods prior to the acquisition date and adjustments for expected effective state tax rates. United States Food and Drug Administration ("FDA") Untitled Letter On June 22, 2015, the FDA issued an Untitled Letter (the "Untitled Letter") alleging that BioD morselized amniotic membrane- based products do not meet the criteria for regulation as human cellular tissue-based products (“HCT/Ps”) solely under Section 361 of the Public Health Service Act and that, as a result, BioD would need a biologics license to lawfully market those morselized products. Since the issuance of the Untitled Letter, BioD and more recently, the Company, have been in discussions with the FDA to communicate their disagreement with the FDA’s assertion that certain products do not fall within the HCT/Ps. The FDA has not changed its position that certain of the BioD acquired products are not eligible for marketing solely under Section 361. In November 2017, the FDA issued its final guidance document related to human tissue titled, “Regulatory Considerations for Human Cells, Tissues, and Cellular and Tissue-Based Products: Minimal Manipulation and Homologous Use” (the “HCT/P Final Guidance”). The HCT/P Final Guidance maintains the FDA’s position that products such as the Company’s morselized amniotic membrane tissue based products do not meet the criteria for regulation solely as HCT/Ps. In addition, the FDA articulated a risk-based approach to enforcement and, while some uses for amniotic membrane tissue-based products would enjoy as much as thirty-six months of enforcement discretion, other high risk uses could be subject to immediate enforcement action. The Company does not believe the uses for its amniotic membrane tissue based products fall into the high-risk category. Nonetheless, the Company can make no assurances that the FDA will continue to exercise its enforcement discretion with respect to the Company’s amniotic membrane tissue based products, and any potential action of the FDA could have a financial impact regarding the sales of such products. Although the Company continues to disagree with the FDA's position, the Company has been considering and continues to consider regulatory approval pathways for its amniotic membrane tissue-based products. Revenues from BioD morselized amniotic material based products for the three and six months ended June 30, 2018 and 2017 were less than 1.0% of consolidated revenues. Contingent Consideration The Company assumed contingent consideration incurred by Derma Sciences related to its acquisitions of BioD and the intellectual property related to the Medihoney product. The Company accounted for the contingent liabilities by recording their fair value on the date of the acquisition based on a discounted cash-flow model. The contingent liabilities recognized as part of the Derma Sciences acquisition relate to the following:
i. | contractual incentive payments that could be made to former equity owners of BioD if net sales of BioD products exceed a certain amount for the twelve-month periods ending June 30, 2017 and 2018 ("BioD Earnout Payments");
ii. | a contractual incentive payment that could be made to the former equity owners if there has been no specific enforcement action or notice by the FDA against the specific BioD products as a result of the Untitled Letter for a certain period after closing as defined by the agreement ("Product Payment"); and
iii. | contractual incentive payments that could be made to the former owner of the intellectual property relating to the Medihoney product line, if net sales of Medihoney products exceed certain amounts defined in the agreement between Derma Sciences and the former owner of the intellectual property of Medihoney for any twelve-month period ("Medihoney Earnout Payments").
At the date of the acquisition, net sales used in estimating the BioD Earnout Payments is based on the weighted average of different possible scenarios using a revenue volatility of 13.5%. The BioD Earnout Payments were valued using a discount rate of 3.0%. The maximum payout related to the BioD Earnout Payments is $26.5 million. The estimated fair value as of February 24, 2017 was $9.1 million. In August 2017, the Company paid $4.8 million for the twelve-month period ending June 30, 2017 component of the BioD Earnout Payments. As of June 30, 2018 and December 31, 2017, the estimated fair value of the remaining portion of the BioD Earnout Payments were zero and $0.3 million. At the date of acquisition, the Company estimated that the probability of the Product Payment was 98.0% and valued it at a discount rate of 2.5%. The maximum payout related to the Product Payment is $29.7 million. The estimated fair value as of February 24, 2017 was $26.8 million. In the second quarter of 2017, the Company adjusted the preliminary estimated fair value to increase the Product Payment by $0.9 million related to additional products that should have been included in the preliminary estimate based on the Merger Agreement. On May 25, 2017, the Company made full payment for the Product Payment of $26.6 million. The payment was included in cash used in business acquisition, net of cash acquired within investing activities in the condensed consolidated statements of cash flows since the payment was made shortly after the acquisition. At the date of the acquisition, the net sales used in estimating the Medihoney Earnout Payments were based on the weighted average of different possible scenarios using revenue volatility of 27.5%. The Medihoney Earnout Payments were valued using a discount rate of 4.5%. The maximum payout related to the Medihoney Earnout Payments is $5.0 million. During the second quarter of 2018, the Company paid $2.0 million for the Medihoney Earnout Payment. The estimated fair value as of June 30, 2018 was $0.2 million. The estimated fair value as of February 24, 2017 and December 31, 2017 was $1.4 million. These fair value measurements were based on significant inputs not observed in the market and thus represented a Level 3 measurement. The contingent considerations are re-measured to fair value at each reporting date until the contingency is resolved, and those changes in fair value are recognized in earnings. Depending on the expected timing of the estimated payments, the acquisition date fair values and subsequent remeasurement could change. Pro Forma Results The following unaudited pro forma financial information summarizes the results of operations for the three and six months ended June 30, 2017 as if the acquisitions of Codman Neurosurgery and Derma Sciences and the divestiture to Natus, which were completed by the Company during 2017, had been completed as of the beginning of 2016. The pro forma results are based upon certain assumptions and estimates, and they give effect to actual operating results prior to the acquisitions and adjustments to reflect (i) the change in interest expense, depreciation expenses, intangible asset amortization and inventory step-up, (ii) timing of recognition for certain expenses that will not be recurring in a post-acquisition period, which includes $2.9 million incurred by Derma Sciences prior to the acquisition and $3.1 million and $12.0 million incurred by Integra, for the three and six months ended June 30, 2018, and (iii) income taxes at a rate consistent with the Company’s statutory rate at the date of the acquisitions. No effect has been given to other cost reductions or operating synergies. As a result, these pro forma results do not necessarily represent results that would have occurred if the acquisition had taken place on the basis assumed above, nor are they indicative of the results of future combined operations.
| Three Months Ended June 30, |  | Six Months Ended June 30,
| 2017 |  | 2017
| (In thousands, except per share amounts)
Total revenue | $ | 360,879 |  |  | $ | 707,539 |
Net income | $ | 14,274 |  |  | $ | 22,850 |
Basic income per share | $ | 0.19 |  |  | $ | 0.30 |

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