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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

or

Commission File No. 0-22958

INTERPORE INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:  (949) 453-3200

          Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or  15(d) of the Securities Exchange Act of 1934 during the proceeding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

          As of November 8, 2002, there were 17,286,161 shares of the registrant’s common stock issued and outstanding.

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Interpore International, Inc.

Index

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Interpore International, Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share data)

See accompanying notes.

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Interpore International, Inc.
Condensed Consolidated Statements of Income
(in thousands, except per share data)
(unaudited)

See accompanying notes.

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Interpore International, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

See accompanying notes.

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Interpore International, Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2002
(unaudited)

1.     Organization and Description of Business

               Interpore International, Inc., doing business as Interpore Cross International, together with its subsidiaries, unless the context implies otherwise (“Interpore Cross”), operates in one business segment: the design, manufacture and marketing of medical devices for the orthopedic marketplace.   Interpore’s products are distributed in the United States and internationally. 

2.     Basis of Presentation

               The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to Securities and Exchange Commission regulations.  In the opinion of management, the accompanying condensed consolidated financial statements include all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the consolidated financial position at September 30, 2002 and the consolidated results of operations and cash flows for the periods ended September 30, 2001 and 2002.

               The accompanying condensed consolidated financial statements include the accounts of Interpore Cross and its subsidiaries after elimination of all significant intercompany transactions.  On July 10, 2001, Interpore Cross completed the acquisition of American OsteoMedix Corporation, (“AOM”), a developer, manufacturer and marketer of minimally invasive surgery products.  The transaction has been accounted for using the purchase method of accounting.  Results of operations of AOM are included in our consolidated results of operations beginning on July 10, 2001. 

               The results of operations and cash flows for the periods ended September 30, 2002 are not necessarily indicative of results to be expected for future quarters or the full year.

               These consolidated financial statements should be read in conjunction with the financial statements included in Interpore Cross’ Annual Report on Form 10-K for the year ended December 31, 2001, as filed with the Securities and Exchange Commission.

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3.     Earnings Per Share

               Basic earnings per share (EPS) is calculated by dividing net earnings by the weighted average number of common shares outstanding for the period.  Diluted EPS reflects the assumed conversion of all dilutive securities, consisting of employee stock options and warrants.  The following table presents the computation of net income per share (in thousands, except per share data):

4.     Inventories

               Inventories are stated at the lower of first-in, first-out average cost or market.  Inventories are comprised of the following (in thousands):

5.     Recent Accounting Pronouncements

               In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations and No. 142, Goodwill and Other Intangible Assets.  SFAS No. 141 addresses financial accounting and reporting for business combinations and requires all business combinations to be accounted for using the purchase method.  SFAS No. 142 addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination.  Goodwill and other intangible assets with indefinite lives are no longer amortized, but instead subject to impairment tests at least annually.  The impairment test is comprised of two parts.  The first step compares the fair value of a reporting unit with its carrying amount, including goodwill.  If the carrying amount exceeds the fair value of a reporting unit, the second step of the goodwill impairment test must be performed.  The second step compares the implied fair value of the reporting unit’s goodwill with the respective carrying amount in order to determine the amount of impairment loss, if any.  In July 2001, upon the acquisition of AOM, Interpore Cross early adopted SFAS No. 141 and SFAS No. 142.  In connection with the acquisition, approximately $20 million of the purchase price was allocated to goodwill.  Prior to July 2001, Interpore Cross had no goodwill or other intangible assets with indefinite lives.  In accordance with SFAS No. 142, Interpore performed the first part of the two-step goodwill impairment test.  For Interpore Cross’ subsidiary, AOM, for which goodwill was recorded, Interpore Cross determined that the fair value

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exceeded the carrying amount as of January 1, 2002.  As a result, the second step of the impairment test was not required.  Interpore Cross performed the annual impairment test during the quarter ending September 30, 2002 and found no impairment of goodwill.

               In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.  SFAS No. 144 Supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of and other related accounting guidance.  SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early application encouraged.  The provisions of SFAS No. 144 generally are to be applied prospectively.  Interpore Cross adopted the statement on January 1, 2002 and believes no impairment of the carrying value of its long-lived assets existed upon adoption and at September 30, 2002.

               In July 2002, the Financial Accounting Standards Board issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities.  SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit and Activity (including Certain Costs Incurred in a Restructuring). The principal difference between SFAS 146 and EITF 94-3 relates to the timing of the recognition of a liability for a cost associated with an exit or disposal activity.  SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred.  Under EITF 94-3, a liability for an exit cost as generally defined in EITF 94-3 is to be recognized at the date of an entity’s commitment to an exit plan.  SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002.

6.     Contingencies

               On September 5, 2000, Interpore Cross’ wholly-owned subsidiary, Cross Medical Products, Inc. (“Cross”), filed suit in the U.S. District Court, Central District of California, against DePuy AcroMed, Inc., a Johnson & Johnson company and Biedermann Motech GmbH, which suit alleges that DePuy AcroMed has infringed and continues to infringe Cross’ U.S. Patent Nos. 5,466,237 and 5,474,555.  These patents relate to screw technology embodied in certain components of the SYNERGY Spinal System.  The Complaint seeks damages for willful past and continuing infringement of the patents.  The Complaint also seeks a declaratory judgment against DePuy AcroMed and Biedermann Motech that Cross is not infringing Biedermann Motech’s Patent No. 5,207,678.  DePuy AcroMed has responded to the Complaint alleging that Cross’ patents are invalid and unenforceable, and alleging that it does not infringe.

               On May 21, 2001, the Court dismissed Cross’ declaratory judgment claim, ruling that Biedermann Motech is not subject to personal jurisdiction in California and is indispensable to the claim.  On January 30, 2002, the Court granted Cross’ motion for summary judgment of infringement of certain claims of the ’237 Patent.  On February 11, 2002, the Court granted Cross’ motion for summary judgment of infringement of certain claims of the ’555 Patent.  On March 20, 2002, the Court granted DePuy AcroMed’s motion for summary judgment of invalidity of the ’237 Patent, ruling that this patent is partially invalid.  Cross is exploring strategies in response to this ruling and currently plans to challenge it.  However, there can be no assurance that Cross will be successful in any such challenge.  The trial is currently scheduled for March 2003.  On October 31, 2002, DePuy AcroMed filed a motion for summary judgment of invalidity of the ‘555 Patent.  That motion is currently scheduled to be heard on November 25, 2002, however, the parties have requested that the court postpone the hearing to December 23, 2002.

               Aside from the patent litigation, the nature of Interpore Cross’ business subjects it to product liability and various other legal proceedings from time to time.  Interpore Cross is currently involved in legal proceedings incidental to the normal conduct of its business.  It does not believe that any liabilities relating to the legal proceedings to which it is a party are likely to be, individually or in the aggregate, material to its consolidated financial condition or results of operations. 

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

Financial Overview

               Our revenues are generated from the sale of medical devices in three principal categories—spine products, orthobiologic products and minimally invasive surgery products.  Our spine products consist of titanium or stainless steel hooks, rods, plates, spacers and screws and related instruments required for the surgeon to assemble a construct which restores the natural anatomy of the spine, keeping it immobilized while a bone graft eventually fuses the vertebrae.  Our orthobiologic products consist of synthetic bone graft substitute materials and products used to derive Autologous Growth Factors™ (AGF™).  AGF fibrinogen-rich extract is used to provide faster, more complete bone growth and enhance the performance of our bone graft products.  Our minimally invasive surgery products consist of instruments and devices used to deliver biocompatible materials into bony structures in a minimally invasive procedure.  The products in this category were obtained in our July 10, 2001 acquisition of American OsteoMedix Corporation (“AOM”), a developer, manufacturer and marketer of minimally invasive surgery products. 

               All of our operations are located in the United States, however, we sell our products to customers both within and outside the United States.  Within the United States, we distribute our products primarily through independent agents.  These independent agents provide a delivery and consultative service to our surgeon and hospital customers and receive commissions based on sales in their territories.  The commissions are reflected in our income statement within selling and marketing expense. 

               For our spine products and minimally invasive surgery products, we invoice hospitals directly following a surgical procedure in which our products are used.  These products are made available to hospitals from consignment inventories maintained by our independent agents, or from loaner implant sets that we ship from our facility.  For our orthobiologic products, we generally ship directly to hospitals from our facility, and we invoice hospitals upon shipment. 

               Outside the United States, we sell our products directly to distributors who maintain an inventory of our products.  We record revenue at the time of shipment to the distributor at prices reflecting a discount from our U.S. list prices.  The distributors service the surgeons and hospitals, deliver products and invoice hospitals directly at prices determined by the distributors. 

               Because our revenues from U.S. hospitals are primarily at list price, and our revenues from international distributors are at a discount to U.S. list prices, our overall gross margin is subject to fluctuation based on our domestic versus international sales mix, with domestic gross margins being somewhat higher than international gross margins.  Additionally, the mix between spine products sales and orthobiologic products sales also affects our gross margins, with slightly higher margins in orthobiologics. 

Critical Accounting Policies and Estimates

               Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.  On an on-going basis, we evaluate our estimates including those related to product returns, bad debts, inventories, intangible assets, income taxes and litigation.  We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions.

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Results of Operations

               The following table presents our results of operations as percentages:

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Three months ended September 30, 2001 and 2002

               For the quarter ended September 30, 2002, net sales of $14.7 million were $2.5 million or 20.4% higher than net sales of $12.2 million for the same period of 2001.  The following table presents net sales by category (in thousands):

               Sales of spine products for the quarter ended September 30, 2002 increased $2.6 million or 37.3% to $9.6 million, compared to $7.0 million for the quarter ended September 30, 2001.  Growth in spine product sales was primarily driven by increased sales of the SYNERGY™ Spinal System, increased sales of our C-TEK® Anterior Cervical Plate System and sales of our recently released GEO STRUCTURE™ Device. 

               Sales of orthobiologic products decreased $451,000 or 9.7% to $4.2 million for the quarter ended September 30, 2002, compared to $4.7 million for the quarter ended September 30, 2001.  We believe that the declines in sales of our orthobiologic products have resulted from the focus of our independent agents on the spinal surgery market.  To combat the decline in sales of our orthobiologic products, we recently introduced an allograft putty product, and we plan to introduce ACCESS™, our improved AGF processing system in the first quarter of 2003.  Additionally, we are expanding a direct sales force and focusing its efforts on our orthobiologic products.  We anticipate that these efforts may begin to offset the declining sales of our orthobiologic products; however, we cannot assure you that we will be able to successfully introduce ACCESS or that ACCESS will begin to contribute to our sales or that our efforts to reverse the sales trend will be successful. 

               Sales of minimally invasive surgery products increased $345,000 or 56.6% to $955,000 for the quarter ended September 30, 2002 compared with $610,000 for the third quarter of 2001. 

               Domestic sales for all product categories increased $2.0 million or 20.4% to $12.0 million for the quarter ended September 30, 2002, compared to $10.0 million for the same period of 2001.  International sales of $2.7 million for the quarter ended September 30, 2002 were higher by $456,000 or 20.2%, compared to $2.3 million for the quarter ended September 30, 2001. 

               For the quarter ended September 30, 2002, the gross margin was 71.0% of net sales compared to 71.7% of net sales for the quarter ended September 30, 2001. 

               Total operating expenses for the quarter ended September 30, 2002 increased by $2.4 million or 31.2% to $10.1 million, compared to $7.7 million for the quarter ended September 30, 2001.  As a percentage of net sales, total operating expenses increased from 62.8% in the quarter ended September 30, 2001 to 68.4% in the quarter ended September 30, 2002.  Research and development expenses increased by $255,000 or 15.9%, due primarily to efforts related to the development of potential new products.  Selling and marketing expenses increased 38.8% or $1.8 million compared to the third quarter of 2001 primarily due to commissions on increased sales, the costs of additional product specialists in the field and the costs of our initial direct sales force for orthobiologic products.  General and administrative expenses for the quarter ended September 30, 2002 increased by $358,000 or 24.1% compared to the quarter ended September 30, 2001, primarily as a result of consulting fees associated with income tax savings projects undertaken during the quarter ended September 30, 2002.

               Total interest and other income decreased $32,000 or 14.3%, to $192,000 for the quarter ended September 30, 2002, compared to $224,000 during the same period of 2001.  The decrease in interest income resulted from lower average cash and cash equivalents balances in 2002 partially offset by increased royalty income.

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               The tax savings projects undertaken during the third quarter ended September 30, 2002 generated a significant tax benefit in the quarter, resulting in the reversal of the $811,000 tax provision that had been recorded for the first six months of 2002.  The effective tax rate for the third quarter of 2001 was 38.5%.

Nine months ended September 30, 2001 and 2002

               For the nine months ended September 30, 2002, net sales of $43.2 million were $6.6 million or 18.2% higher than net sales of $36.5 million for the same period of 2001.  The following table presents net sales by category (in thousands):

               Sales of spine products for the nine months ended September 30, 2002 increased by $5.7 million or 27.0% to $26.7 million, compared to $21.0 million for the nine months ended September 30, 2001.  Growth in spine product sales was driven primarily by increased domestic sales of the SYNERGY Spinal System and increased sales of the C-TEK Anterior Cervical Plate System. 

               Sales of orthobiologic products decreased $1.5 million or 10.1% to $13.4 million for the nine months ended September 30, 2002, compared to $14.9 million for the nine months ended September 30, 2001.  To combat the decline in sales of our orthobiologic products, we recently introduced an allograft putty product, and we plan to introduce ACCESS, our improved AGF processing system in the first quarter of 2003.  Additionally, we are expanding a direct sales force and focusing its efforts on our orthobiologic products.  We anticipate that these efforts may begin to offset the declining sales of our orthobiologic products; however, we cannot assure you that we will be able to successfully introduce ACCESS or that ACCESS will begin to contribute to our sales or that our efforts to reverse the sales trend will be successful. 

               Sales of minimally invasive surgery products were $3.1 million for the nine months ended September 30, 2002, compared to $610,000 for the nine months ended September 30, 2001.  These products were acquired as part of the AOM acquisition on July 10, 2001, and accordingly, the 2001 period only included sales since the acquisition.

               Domestic sales for all product categories increased $6.8 million or 23.5% to $35.4 million for the nine months ended September 30, 2002, compared to $28.7 million for the same period of 2001.  International sales of $7.7 million for the nine months ended September 30, 2002 were approximately the same for the nine months ended September 30, 2001.

               For the nine months ended September 30, 2002, the gross margin was 71.9% of sales compared to 71.1% of sales for the nine months ended September 30, 2001. 

               Total operating expenses for the nine months ended September 30, 2002 increased by $7.0 million or 32.1% to $28.9 million, compared to $21.9 million for the same period of 2001.  As a percentage of net sales, total operating expenses increased from 59.8% in the nine months ended September 30, 2001 to 66.9% in the same period of 2002.  Research and development expenses increased for the nine months ended September 30, 2002 by $948,000 or 19.4% as compared to the same period in 2001 due primarily to efforts related to the development of potential new products and expenses related to AOM.  Selling and marketing expenses for the nine months ended September 30, 2002 increased $4.6 million or 34.7% compared to the nine months ended September 30, 2001, primarily due to commissions on increased sales, the costs of additional sales personnel and expenses related to AOM.  General and administrative expenses increased by $1.5 million or 39.4% compared to the nine months ended September 30,

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2001, primarily as a result of legal expenses associated with the DePuy AcroMed patent litigation, which expenses increased by $891,000 to $1.2 million for the nine months ended September 30, 2002, increased products liability insurance on higher sales and expenses related to AOM.

               Total interest and other income decreased $326,000 or 39.2%, to $506,000 for the nine months ended September 30, 2002, compared to $832,000 during the same period of 2001.  The decrease in  interest income resulted from lower average cash and cash equivalents balances in 2002.

               Because of the significant tax benefit in 2002 resulting from tax savings projects undertaken during the third quarter ended September 30, 2002, we recorded no income tax provision for the nine months ended September 30, 2002.  The effective tax rate for the nine month period ended September 30, 2001 was 38.5%.  We anticipate that no income tax provision will be recorded for the year 2002, but that the effective tax rate for the year 2003 will return to a rate approximating 38%, absent any further tax savings projects.

Liquidity and Capital Resources

               At September 30, 2002, cash and cash equivalents were $1.3 million, down $5.2 million from $6.5 million at December 31, 2001.  We have a $10.0 million secured revolving bank line of credit which expires in June 2005.  At September 30, 2002, we had borrowed approximately $3.3 million under this facility to fund our working capital needs. 

               During the nine months ended September 30, 2002, we invested significantly in the development of new spine products and orthobiologic products scheduled for market launch in 2002 and 2003.  In addition to product development costs, we require substantial inventories to support the launch and future sales of these products.  This is especially significant in our spine business, where we must build complete sets of implants in many designs and sizes together with the instruments required for their surgical implantation.  Enough complete sets must be manufactured to support consignment inventory needs for our domestic sales agents and for some U.S. hospitals as well as for loaner sets maintained at our facilities.  As a result, in the first nine months of 2002, our inventories grew by $11.7 million.  This was the primary reason for our $7.2 million net cash used in operations for the nine months ended September 30, 2002.

               We plan to continue making significant investments in initial inventory levels for new products.  We also intend to continue to invest in the development of our business.  We believe we currently possess sufficient resources, including our revolving bank line of credit, to meet the cash requirements of our operations for at least the next year.  In addition, we have used and may continue to use our cash, our common stock, or a combination of both to pay for purchased technologies, product lines, mergers and acquisitions.  Some of these activities may require resources in excess of those which we currently possess, and we cannot assure you that we will be able to raise additional capital on satisfactory terms, if at all.

               At September 30, 2002, we had no material commitments for capital expenditures.

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Certain Business Considerations

                    Investors are cautioned that certain statements contained in or incorporated by reference into this Quarterly Report on Form 10-Q, or which are otherwise made by us or on our behalf are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements include statements that are predictive in nature, which depend upon or refer to future events or conditions, which include words such as “believes,” “plans,” “anticipates,” “estimates,” “expects” or similar expressions.  In addition, any statements concerning future financial performance, ongoing business strategies or prospects, and possible future actions, which may be provided by our management, are also forward-looking statements.  Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about our company, economic and market factors and the industry in which we do business, among other things.  These statements are not guaranties of future performance and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

               Actual events and results may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors.  Factors that could cause our actual performance and future events and actions to differ materially from such forward-looking statements, include, but are not limited to those discussed below and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2001.

We are dependent on a few products which may be rendered obsolete. 

               A majority of our revenues currently comes from SYNERGY and PRO OSTEON™ sales.  There can be no assurance that we will be successful in increasing sales of our current product offering.  Additionally, there can be no assurance that our efforts to develop new products will be successful.  Even if our development efforts are successful, there can be no assurance that we will be successful in marketing and selling our new products.  Moreover, our competitors may develop and successfully commercialize medical devices that directly or indirectly accomplish what our products are designed to accomplish in a superior and less expensive manner.  If our competitors’ products prove to be more successful than ours, our products could be rendered obsolete.  As a result, we may not be able to produce sufficient sales to maintain profitability. 

If we fail to compete successfully against existing or potential competitors, our operating results may be adversely affected. 

               Our principal global competitors with respect to our spinal implant product line are Medtronic Sofamor Danek USA, DePuy AcroMed, Inc., a Johnson & Johnson company, and SYNTHES-STRATEC, Inc. Our principal global competitors with respect to our orthobiologic products include DePuy AcroMed, Osteotech, Inc., Orthovita, GenSci Regeneration Sciences, Regeneration Technologies and Wright Medical Technology. Our principal competitor with respect to our minimally invasive surgery products is Kyphon Inc.  We compete in all of our markets primarily on the basis of product performance and price, as well as customer loyalty and service. Many of our competitors have broader product lines than we do.  Accordingly, they could substantially increase the resources they devote to the development and marketing of products that are competitive with ours.  Many of our potential customers have existing relationships with our competitors that could make it difficult for us to continue to penetrate the markets for our products.  If we fail to compete successfully against our existing or potential competitors, our operating results may be adversely affected.

We may not be able to develop new products that will be accepted by the market. 

               Our future growth will be dependent on our ability to develop and introduce new products, including enhancements to our existing products.  We cannot assure you that we will be able to successfully develop or market new products or that any of our future products will be accepted by our customers.  If we do not develop new products in time to meet market demand or if there is insufficient demand for these products, our revenues and profitability may be adversely affected. 

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               The success of any new product offerings or enhancements to existing product offerings will depend on several factors, including our ability to:

               In addition, we have spent and expect to continue to spend significant cash on the development, product launch and continued marketing of new products and if there is insufficient demand for these new products, our cash flow could suffer and our liquidity would be adversely affected.

The long-term efficacy and market acceptance of AGF is uncertain. 

               Because our AGF related products were introduced under a 510(k) clearance, we lack long-term clinical data regarding the efficacy and long-term results of AGF.  To date, we have completed no long-term clinical studies of AGF.  If long-term studies or clinical experience indicate that procedures involving AGF do not provide patients with improved clinical outcomes, anticipated sales of our AGF related products may never materialize.  Our success in selling our AGF related products will depend, in large part, on the medical community’s acceptance of AGF.  The medical community’s acceptance of AGF will depend upon our ability to demonstrate the efficacy of AGF and its advantages, favorable clinical performance and cost-effectiveness.  The medical community’s acceptance of AGF will also depend upon our ability to introduce ACCESS, a new processing system for AGF that is less complex.  We cannot predict whether the medical community will accept AGF or, if accepted, the extent of its use.  If long-term studies or clinical experience indicate that AGF causes negative effects, we could be subject to significant liability. 

Our minimally invasive surgery products business may not achieve the growth we expect and our profitability could be adversely affected.

               Our minimally invasive surgery products business was obtained through our July 2001 acquisition of American OsteoMedix Corporation (“AOM”).  To date, our revenues from this business have been below expectation.  To address this, we are investing significantly in the hiring and training of a group of product specialists to work directly with our independent sales agencies in obtaining new surgeon customers, training of surgeons and sales representatives, and assisting surgeons in educating the doctors that comprise their referral base about the benefits of procedures using these products.  We believe that these efforts may allow us to achieve the expected growth in AOM revenues. We performed our annual impairment test of goodwill during the quarter ending September 30, 2002 and found no impairment of goodwill.  However, we cannot assure you that our efforts will be successful.  We may ultimately determine that our minimally invasive surgery products must be distributed through a sales force consisting of direct sales representatives.  If we are unsuccessful in our efforts with the product specialists, or if we ultimately decide to create a direct sales force for these products, which would require a substantial investment, our profitability could be materially adversely affected.

We face risks related to the maintenance, upgrading and expansion of our domestic distribution network. 

               In domestic markets, we primarily use independent sales agents for the distribution of our spine products and orthobiologic products.  However, because of the agents’ focus on selling only to spinal surgeons, our orthobiologic products sales have suffered.  Therefore, we have created an initial direct sales force to distribute our orthobiologic products in certain underperforming territories, and we plan to significantly increase this sales force in the future.  However, we cannot assure you that we will be successful in our efforts to identify and hire qualified

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candidates for these positions, or that such candidates, upon their hiring, will be successful in distributing our orthobiologic products.  Additionally, this effort requires a substantial investment and our profitability could be adversely affected as a result.

                    We expect to continue to rely primarily on independent agents for the domestic distribution of our spine products.  Independent commissioned sales agents may represent other medical devices for a variety of manufacturers and may not dedicate enough time or attention to selling our products.  Furthermore, we expend significant resources to train and educate new independent agents about our products and our marketing programs.  Our ability to recruit independent sales agents has been aided by some of our competitors’ replacement of independent agents with direct sales representatives.  However, our competitors may not continue to utilize direct sales representatives and we cannot assure you that we will continue to be able to attract new or retain our current independent sales agents.  We also cannot assure you that we will be able to develop an effective distribution network or that our independent agents will be able to continue to increase sales or maintain current sales levels of our products.

Product introductions or modifications may be delayed or canceled as a result of the FDA regulatory process, which could cause our sales to decline. 

               The medical devices we manufacture and market are subject to rigorous regulation by the FDA and numerous other federal, state and foreign governmental authorities.  Our failure to comply with such regulations could lead to the imposition of injunctions, suspensions or loss of regulatory approvals, product recalls, termination of distribution, or product seizures.  In the most egregious cases, criminal sanctions or closure of our manufacturing facility are possible.  The process of obtaining regulatory approvals to market a medical device, particularly from the FDA, can be costly and time-consuming, and there can be no assurance that such approvals will be granted on a timely basis, if at all.  The regulatory process may delay the marketing of new products for lengthy periods and impose substantial additional costs or it may prevent the introduction of new products altogether.  In particular, the FDA permits commercial distribution of a new medical device only after the FDA has cleared a 510(k) premarket notification or has approved a Premarket Approval application, or PMA, for such device.  The FDA will clear marketing of a medical device through the 510(k) process if it is demonstrated that the new product is substantially equivalent to other 510(k)-cleared products.  The PMA approval process is more costly, lengthy and uncertain than the 510(k) premarket notification process.  There can be no assurance that any new products we develop will be subject to the shorter 510(k) clearance process and therefore significant delays in the introduction of any new products that we develop may occur.  We anticipate that our products that are in final development will be eligible for the 510(k) premarket notification process.  If the FDA does not clear marketing of our products in final development through the 510(k) clearance process, we will be forced to comply with the PMA approval process in order to obtain FDA approval for these products.  If we choose to go through the PMA approval process, there will be significant costs and delays in the introduction of our new products, if they are approved at all.  Moreover, foreign governmental authorities have become increasingly stringent and we may be subject to more rigorous regulation by foreign governmental authorities in the future.  Any inability or failure of our foreign independent distributors to comply with the varying regulations or the imposition of new regulations could restrict such distributors’ ability to sell our products internationally and thereby adversely affect our business.  All products and manufacturing facilities are subject to continual review and periodic inspection by the FDA.  The discovery of previously unknown problems with our company or our products or facilities may result in product labeling restrictions, recall, or withdrawal of the products from the market.  In addition, the FDA actively enforces regulations prohibiting the promotion of medical devices for unapproved indications.  If the FDA determines that we have marketed our products for off-label use, we could be subject to fines, injunctions or other penalties. 

We may be subject to product liability claims and our limited product liability insurance may not be sufficient to cover the claims, or we may be required to recall our products. 

               We manufacture medical devices that are used on patients in surgical procedures, and we may be subject to product liability claims and product recalls.  The spinal implant industry has been historically litigious and we face an inherent business risk of financial exposure to product liability claims.  Since our spinal products are implanted in the human body, manufacturing errors or design defects could result in injury or death to the patient, and could result in a recall of our products and substantial monetary damages.  Any product liability claim brought against us, with or without merit, could result in an increase to our product liability insurance premiums or our inability to

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secure coverage in the future.  We would also have to pay any amount awarded by a court in excess of our policy limits.  In addition, any recall of our products, whether initiated by us or by a regulatory agency, may result in adverse publicity for us that could have a material adverse effect on our business, financial condition and results of operations.  Our product liability insurance policies have various exclusions, and we may be subject to a product liability claim or recall for which we have no insurance coverage, in which case we may have to pay the entire amount of the award or costs of the recall.  Finally, product liability insurance is expensive and may not be available in the future on acceptable terms, or at all. 

We may face challenges to our patents and proprietary rights. 

               We rely on a combination of patents, trade secrets and nondisclosure agreements to protect our proprietary intellectual property.  Our patent positions and those of other medical device companies are uncertain and involve complex and evolving legal and factual questions.  There can be no assurance that pending patent applications will result in issued patents, that patents issued to or licensed by us will not be challenged or circumvented by competitors or that such patents will be found to be valid or sufficiently broad to protect our technology or to provide us with any competitive advantage.  For example, one of our patents, U.S. Patent No. 5,466,237, was recently found to be partially invalid.  See “Item 3 - Legal Proceedings.”  Third parties could also obtain patents that may require licensing for the conduct of our business, and there can be no assurance that the required licenses would be available.  We also rely on nondisclosure agreements with certain employees, consultants and other parties to protect, in part, trade secrets and other proprietary technology.  There can be no assurance that these agreements will not be breached, that we will have adequate remedies for any breach, that others will not independently develop substantially equivalent proprietary information or that third parties will not otherwise gain access to our trade secrets and proprietary knowledge.  If our intellectual property is not adequately protected, our competitors could use the intellectual property that we have developed to enhance their products and compete more directly with us, which could result in a decrease in our market share and profits. 

               The medical product industry is characterized by frequent and substantial intellectual property litigation and competitors may resort to intellectual property litigation as a means of competition.  Intellectual property litigation is complex and expensive, and the outcome of such litigation is difficult to predict.  Any future litigation, regardless of the outcome, could result in substantial expense and significant diversion of the efforts of our technical and management personnel.  Litigation may also be necessary to enforce our patents and license agreements, to protect our trade secrets or know-how or to determine the enforceability, scope and validity of the proprietary rights of others.  For example, we are currently involved in ongoing patent litigation against DePuy Acromed, Inc., a Johnson and Johnson company, and Biederman Motech GmbH.  An adverse determination in any such proceeding could subject us to significant liabilities to third parties, or require us to seek licenses from third parties or pay royalties that may be substantial.  Accordingly, an adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing or selling certain of our products which in turn would have a material adverse effect on our business, financial condition and results of operations. 

Possible denial of third-party reimbursement could have a material adverse effect on our future business, results of operations and financial condition. 

               In the United States, our products are purchased by hospitals that are reimbursed for the devices provided to their patients by third-party payors, such as governmental programs (e.g., Medicare and Medicaid), private insurance plans and managed care programs.  These third-party payors may deny reimbursement if they determine that a device used in a procedure was not used in accordance with cost-effective treatment methods, as determined by the third-party payor, or was used for an unapproved indication.  Also, third-party payors are increasingly challenging the prices charged for medical products and services.  In addition, we believe the increasing emphasis on managed care in the United States may put pressure on the prices and usage of our products, which may adversely affect product sales.  In international markets, reimbursement and healthcare payment systems vary significantly by country and many countries have instituted price ceilings on specific product lines.  There can be no assurance that our products will be considered cost-effective by third-party payors, that reimbursement will be available or, if available, that the third-party payors’ reimbursement policies will not adversely affect our ability to sell our products profitably. 

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We are dependent on our suppliers and the loss of any of them could adversely affect our business. 

               We do not manufacture the components for our spinal implants or instruments or minimally invasive surgery products; rather, we are dependent upon several suppliers for the manufacturing of such components.  Also, the UltraConcentrator, one of our products used to collect AGF, is manufactured under an exclusive supply agreement with a vendor that itself has a sole source of supply for filter material, a key component of the UltraConcentrator.  In the event that we are unable to obtain components for any of our products, or obtain such components on commercially reasonable terms, we may not be able to manufacture or distribute our products on a timely and competitive basis, or at all.  Any delays in product availability or costs incurred in locating alternative suppliers could have a material adverse effect on our operations. 

The harvesting of coral is subject to regulation which could affect our ability to obtain sufficient quantities of coral in the future. 

               The harvesting and import of the coral used for our coral-based orthobiologic products must comply with the requirements of the Convention on International Trade of Endangered Species of Wild Fauna and Flora.  As a result, we must register and obtain licensure from the U.S. Department of Fish and Wildlife for both the import of raw coral and the export of finished product.  In the future, regulations could make the import or export of coral or coral-derived products prohibitive and could interrupt our ability to supply product.  We cannot assure you that our supply of raw coral is sufficient, that we will be able to obtain sufficient quantities of coral in the future or that future regulations will not prohibit its use altogether. 

Our business could be materially adversely impacted by risks inherent in international markets. 

               In 2001, approximately 22% of our sales were generated outside the United States.  We expect that such sales will continue to account for a significant portion of our revenue in the future.  Our international sales subject us to other inherent risks, including the following:

               If we fail to successfully market and sell our products in international markets, our business, financial condition, results of operations, and cash flows could be materially and adversely affected. 

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Future acquisitions could adversely affect our operations or financial results. 

               From time to time, we consider acquisition of technology product lines or businesses to supplement our current product offering.  Any such future acquisitions involve risks such as the following:

               The information contained in this report is as of September 30, 2002, unless expressly stated as of another date.  We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.  We also may make additional disclosures in our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K that we may file from time to time with the Securities and Exchange Commission.  Other factors besides those listed here could also adversely affect us.  This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995.

Item 3.           Quantitative and Qualitative Disclosures About Market Risk

               We are exposed to market risk for changes in interest rates related primarily to our cash, cash equivalent balances, marketable securities and borrowings under our secured revolving bank line of credit.  However, as all of our investments are in short-term instruments, we believe that we have no material market risk exposure.  In addition, our borrowings under the secured revolving bank line of credit bear interest at variable rates based on bank prime or LIBOR and we believe a hypothetical 10 percent change in that rate would not create material market risk exposure.

Item 4.           Controls and Procedures

               We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.  In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

               Within 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures.  Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.

               There have been no significant changes in our internal controls or in other factors that could significantly affect the internal controls subsequent to the date we completed our evaluation.

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SIGNATURES

Pursuant to the requirements 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.

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INTERPORE INTERNATIONAL, INC.

Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Certification

I, David C. Mercer, certify that:

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INTERPORE INTERNATIONAL INC.

Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Certification

I, Richard L. Harrison, certify that: