UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
X EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended December 31, 1996
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from to
Commission file number 33-69286
WRIGHT MEDICAL TECHNOLOGY, INC.
(Exact name of registrant as specified in its charter)
Delaware 62-1532765
(State or other jurisdiction (I.R.S. employer
of incorporation or organization) identification no.)
5677 Airline Road, Arlington, Tennessee 38002
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (901) 867-9971
Securities registered pursuant to Section 12(b) of the Securities Exchange
Act of 1934: None
Securities registered pursuant to Section 12(g) of the Securities Exchange
Act of 1934: None
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 preceding 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. Yes X No
The registrant has no publicly traded equity securities, no market
quotations are available and accordingly, information is not provided with
respect to the aggregate market value of voting stock held by non-affiliates of
the registrant.
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of March 18, 1997 the registrant had 9,199,025 shares outstanding of
Class A Common Stock, $0.001 par value per share.
DOCUMENTS INCORPORATED BY REFERENCE. None
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TABLE OF CONTENTS
Page
PART I
Item 1. Business
Overview..................................3
Market Overview...........................4
Principal Products........................6
Biologic Product Opportunities...........10
Marketing and Distribution...............12
Competition..............................13
Manufacturing and Quality Control........14
Government Regulations...................14
Research and Product Development.........16
Principal Customers......................17
Raw Materials............................18
Environmental............................18
Insurance................................18
Patents and Trademarks...................19
Royalty and Other Payments...............19
Seasonality..............................19
Employees................................19
Item 2. Properties........................................19
Item 3. Legal Proceedings.................................20
Item 4. Submission of Matters to a Vote of Security
Holders...........................................21
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters...............................22
Item 6. Selected Financial Data...........................23
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations...............24
Item 8. Financial Statements and Supplementary Data.......31
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...............31
PART III
Item 10. Directors and Executive Officers of the
Registrant........................................32
Item 11. Executive Compensation............................35
Item 12. Security Ownership of Certain Beneficial Owners
and Management ...................................41
Item 13. Certain Relationships and Related Transactions....44
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K...............................48
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PART I.
ITEM 1. BUSINESS.
Overview
Wright Medical Technology, Inc., a Delaware corporation (collectively
with its subsidiaries, the "Company") is a designer, manufacturer and worldwide
distributor of orthopaedic implant devices and instrumentation for
reconstruction and fixation. Reconstructive devices are for joint arthroplasty
that involve the replacement with mechanical substitutes of impaired skeletal
joints such as knees, hips, shoulders, and the small joints of the elbow, hands
and feet. The Company also offers devices for 1) fracture fixation due to trauma
2) arthroscopic surgery of the knee, shoulder and extremities, and 3) the spine
to aid in correction of deformity and instability. In addition, the Company is
developing a wide range of new biological products that are designed to solve
orthopaedic problems by, in some cases, delaying or obviating the need for
traditional orthopaedic solutions. The Company's business strategy is to design
and develop unique and innovative products to solve clinical orthopaedic
problems. The Company was founded to acquire, in July 1993, substantially all
the assets of the large joint orthopaedic implant business of Dow Corning Wright
Corporation, a subsidiary of Dow Corning Corporation (collectively "DCW")(the
"Acquisition").
In furtherance of its commitment to find innovative solutions to
orthopaedic problems, the Company 1) entered into a joint venture agreement in
mid 1996 with Tissue Engineering, Inc. ("TE Inc.") a Boston, Massachusetts
company that develops collagen-based scaffolds for ligament and tendon
reconstruction and other orthopaedic applications and 2) purchased the
biomaterials business of the Industrial Division of United States Gypsum Company
("USG"), a subsidiary of USG Corporation, which had manufactured and licensed to
the Company its OSTEOSET(TM) medical grade calcium sulfate product. With
OSTEOSET(TM) bone void filler now approved by the U. S. Food and Drug
Administration ("FDA"), the Company can offer the medical community a specially
formulated medical grade calcium sulfate, that surgeons may use to treat defects
in long bones caused by surgery, tumors, trauma, implant revisions and
infections without questions of biological transfer of viruses and diseases.
Biological skeletal repair is a new area of orthopaedics that offers the
possibility of novel treatments for musculoskeletal injuries and defects using
the body's own healing responses.
The Company's headquarters, manufacturing and distribution facilities
are located in Arlington, Tennessee. Products are distributed throughout the
world through a combination of distributors and wholly owned subsidiaries.
Principal markets include the United States, Canada, Japan, France, and
Australia.
Unless the context otherwise requires, the term "Company" as used
herein refers to Wright Medical Technology, Inc. and its subsidiaries.
Throughout this document, products are discussed that are currently
under development or, for which clearance by the FDA (or applicable foreign
regulatory clearance) has not been received. The Company can give no
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assurance that any of these products will in fact be successfully developed,
that the necessary FDA or foreign approvals will be received or that, if
developed and approved, a market for these products will exist.
This document contains forecasts and projections that are forward-
looking statements and are based on management's current expectations of the
Company's near term results, based on current information available pertaining
to the Company. Actual future results and trends may differ materially depending
on a variety of factors, including competition in the marketplace, demographic
trends, product research and development, and other factors. Results of
operations in the industry generally show a seasonal pattern, as customers
reduce shipments during the warm weather months.
Market Overview
Demographic Trends. The United States population over 65 years of age
continues to grow as a percentage of the total population. The aging of the
population is significant in that approximately 70% of all joint implants are
for patients over 65 years of age. Osteoarthritis (degenerative joint disease)
affects over 15 million people in the United States and is the primary
indication for orthopaedic implants. Management believes that as the population
ages, the incidence of osteoarthritis and other ailments will increase and, as a
consequence, the demand for orthopaedic implants and new solutions for medical
problems requiring orthopaedic applications should rise. The incidence of
rheumatoid arthritis, another major disease leading to the need for implants
that currently affects over two million people, may also increase with the aging
of the population. Management believes that another factor affecting growth of
implant use is the increasingly active lifestyle of many older Americans. A more
active lifestyle not only accelerates the joint degeneration process, but also
increases the expectations that people have of their bodies. Joint degeneration
leads to pain and decreased mobility, while active lifestyles also may result in
more sports-related traumatic injuries. As a result, the Company believes that
the need for new and innovative orthopaedic solutions will continue to grow.
Large Joint Orthopaedic Implant Market. Since its introduction in the
early 1960's, total large joint replacement (knees, hips and shoulders)
utilizing orthopaedic implants has grown rapidly to become the largest segment
of the global orthopaedic implant market. Over the last ten years, the number of
total joint procedures performed to replace arthritic or damaged joints has
increased steadily. As a result of managed care, the industry has experienced
pricing pressures over the past few years which has stabilized or reduced the
average price of an implant per procedure. Nevertheless, the Company believes
that the number of knee and hip replacement procedures performed in the United
States will continue to increase. Management expects that revision procedures,
in which new implants replace existing knee and hip implants, will contribute to
future industry growth. Management believes that the Company is well positioned
in the expanding primary and revision knee markets with its ADVANTIM(R) Knee
System, AXIOM(R) Knee System and its new ADVANCE(TM) Knee System. While the
market for hip procedures is growing at a smaller rate, management believes the
Company is positioned to increase market share in that segment especially with
its PERFECTA(R) Hip System acquired in the acquisition of Orthomet, Inc.
("Orthomet") and with its new product offerings for surface
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replacement and alternative bearing surfaces such as metal-on-metal and
ceramic-on-ceramic.
Small Joint Orthopaedic Implant Market. The small joint orthopaedic
implant market includes implants for hands, feet, elbow, and wrists. The Company
believes that the annual number of finger and toe joints implanted in the United
States dropped significantly in 1993 (at the height of market concerns related
to silicone products), but has subsequently rebounded. Sales and marketing of
small joint implants involves targeted efforts to specific groups of physicians.
Approximately 1,000 orthopaedic hand specialists and 600 plastic surgeons employ
hand and wrist implants and approximately 500 orthopaedic foot specialists and
7,000 podiatric surgeons perform foot procedures. The Company anticipates that
the market for small joint orthopaedic implants will grow in the near term as
the elderly population continues to grow.
Trauma. Devices for trauma applications are one of the largest segments
of the orthopaedic market. Current market estimates place domestic revenue for
1996 in excess of $711 million. Management believes that a number of its
fracture fixation products, such as the CONCISE(TM) Compression Hip Screw
System, the Medoff Sliding Plate, the TYLOK(TM) High Tension Cerclage Cabling
System and the CANNULATED PLUS(TM) Screw System, are innovative and will enable
the Company to gain market share in one of orthopaedics' most stable markets. In
addition, the Company has plans to introduce in 1997 its innovative and patented
Magellan(TM) Intramedullary Nailing System which will provide access to the
lucrative long bone trauma fixation market, and an external fixation system.
Arthroscopy. The desire for less invasive surgical procedures that
results in shortened hospital stays, quicker recovery times, and less patient
discomfort has also resulted in arthroscopic procedures becoming one of the
fastest growing segments of the orthopaedic market. The current arthroscopy
market in the United States is estimated to be in excess of $131 million with a
growth rate of approximately 8% over prior year. Today's typical arthroscopy
procedure requires minimal operating room time and little or no hospitalization,
with approximately 65 percent of such procedures occurring outside the hospital
setting. As a result, third party payors, patients and their physicians have
embraced the use of minimally invasive procedures with significant growth
expected to continue. The Company's introduction into this market came in 1995
with the sale of the QUESTUS(TM) LEADING EDGE(TM) Sheathed Knives and Grasper
Cutter, and its patented ANCHORLOK(TM) soft tissue anchor. In addition, the
Company is developing what it believes will be a novel system of instrumentation
for repair of the anterior cruciate ligament, the injury which is the most
common orthopaedic injury in younger patients.
Spine. Current estimates are that approximately 80% of the population
will experience back pain at some point in their adult lives. Back pain is the
second most frequent reason that people visit their physician and is the leading
cause of missed work days. Although a majority of patients are treated with a
combination of non-surgical treatments, over 700,000 surgical back procedures
are performed in the U.S. each year. In 1996, this market grew approximately 20%
over prior year. Historically, the spinal implant market has increased at
approximately 15% since the late 1980's making it
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one of the highest growth areas in orthopaedics. With the introduction in late
1995 of the WRIGHTLOCK(TM) posterior fixation system and introduction of the
VERSALOK(TM) low back system, currently underway, the Company believes it has a
superior system for correcting scoliosis and certain types of spinal
instability. The Company expects to introduce an innovative anterior cervical
plating system later in 1997.
Principal Products
The Company's revenues are derived primarily from the sale of
orthopaedic implant devices for reconstruction and fixation.
Reconstructive Knee Products
The Company currently markets several reconstructive knee systems
including the AXIOM(TM) Total Knee System (the "Axiom Knee"), the ADVANTIM(R)
Total Knee System (the "Advantim Knee"), and the ADVANCE(TM) Total Knee System
(the "ADVANCE Knee"). Each of these systems is designed to duplicate the
anatomical function of the patient's knee, thereby improving its range of motion
and stability. In a typical knee replacement, the surgeon may replace the
articulating surfaces of the knee: the knee cap (patella), top of the shin bone
(tibia) and bottom of the thigh bone (femur). In a total knee replacement the
surgeon can choose to leave the posterior cruciate ligament intact
(necessitating a PCL sparing knee component) or remove that ligament
(necessitating a posterior stabilized knee component).
In early 1995, the Company entered into a product licensing agreement
with the Hospital for Special Surgery ("HSS") to develop a new standard for
primary posterior stabilized total knee arthroplasty. With over 20 years
experience in designing total knee replacements, the HSS team of surgeons and
engineers working with the Company developed the ADVANCE Knee. The design
reduces stress and enhances implant survivorship while still maintaining
rotational freedom. Further, the biomechanics of the ADVANCE Knee design allow
for a greater range of motion than traditional posterior stabilized knees. There
are many key design advantages. The Company believes that the ADVANCE Knee is
one of the most advanced posterior stabilized knee systems on the market. The
Company anticipates introducing the PCL sparing components of the ADVANCE Knee
in late 1997.
Since its formation, the Company has been committed to ultrahigh
molecular weight polyethylene research and development. As a result, the Company
developed DURAMER(TM) EtO Sterilized polyethylene which eliminates the incidence
of gamma-induced oxidation and associated poly wear in the joint. There are
essentially no levels of EtO left in the Company's products after sterilization.
Products are aerated until the EtO is dissipated and any amounts remaining are
at least ten times lower than what is considered safe by the FDA.
The Company's primary knee product is the Advantim Knee, designed to
address the needs of the high demand patient. It has almost 15 years of clinical
success.
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Reconstructive Hip Products
The Company currently markets a wide choice of hip products including
those with brand names of PERFECTA(R), EXTEND(TM), INFINITY(R), NEXUS(R) II,
BRIDGE(R), and the INTERSEAL(R) Acetabular System. These systems are designed
to replace the natural hip joint. The Company's hip implants consist of the same
basic parts as the natural hip, including a femoral stem inserted into the femur
(thigh bone) with a spherical femoral head (ball) and an acetabular cup (socket)
on which the femoral head articulates. The Company's hip systems include several
different femoral stem designs and several acetabular cup designs. Each design
is produced in a variety of sizes for either low- demand or high-demand
patients. Surgeons have the option of interchanging stem, head and acetabular
cup designs to meet their own preferences and individual patient requirements.
The Company also has products to address hemi-arthroplasties where only the
femoral component of the hip is replaced. The femoral stems currently marketed
by the Company are made of a titanium or cobalt chrome alloy. Acetabular cups
are comprised of ultra high molecular weight polyethylene available with or
without a metal backed shell with different surfaces to enhance fixation to the
pelvis.
The Company's femoral stems are offered in a variety of geometric
designs and in smooth, porous-coated and textured surfaces including
hydroxylapatite. These products allow for bone on-growth, bone in-growth,
press-fit or cemented applications.
The INTERSEAL(R) Acetabular Cup is a system of titanium porous-coated
metal shells and modular liners providing the surgeon with extensive
intraoperative flexibility. This product was introduced in 1995 and continues to
do well. The hemispherical design provides rigid fixation at the rim with a
secure lock at the shell/liner interface. An apical hole in the shell allows the
surgeon to confirm that the shell is bottomed out in the pelvis, and a plug
seals the hole from the invasion of particulate. The system also features a
quadrant style shell featuring optional screw fixation and lateralized liners
for revision cases. In 1996 a multiple hole cup for difficult revision cases and
liners with additional inner-diameter choices were commercialized. The Company
believes that the superior characteristics of the INTERSEAL(R) System will also
benefit the sales of its existing and newly released hip stems.
The S.O.S.(TM), or Segmented Orthopaedic System, was created to offer
limb salvage to the patient who suffers bone loss due to cancer, trauma or
failed implants. The Company believes that the present system, which consists of
the Proximal Femur System and the Distal Femur System, is the only FDA cleared
product of its kind on the market. The Company is in the process of expanding
this system to include a proximal tibia, total femur and total humerus.
The Company has also developed three new innovative hip designs which
it plans to commercialize in 1997 under various FDA approval processes. First,
the CONSERVE(TM) Hip System is a product developed to replace only the surface
of the femoral head thereby obviating the need for a full femoral stem
prosthesis which requires the removal of a great deal of the patient's healthy
bone. Second, the Company has developed the TRANSCEND(TM) metal-on- metal and
ceramic-on-ceramic articulating surface systems (both products are awaiting FDA
approvals which may require clinical studies). The Company
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believes that these systems, which eliminate the use of a polyethylene bearing
surface in the acetabular component, will provide advantages over conventional
hip systems due to anticipated reductions in wear debris.
These product lines should place the Company in an excellent position
to sustain rapid growth in primary and revision hip surgery, as well as limb
salvage cases. The products allow the orthopaedic surgeon a wide range of
material and design choices to solve the varied medical problems of individual
patients.
Small Joint and Upper Extremity Products. Small joint orthopaedic
implants have a long clinical history and over one million devices have been
implanted during their 25-year history. Many of the Company's small joint
orthopaedic implants were developed initially and patented by surgeon- inventor
Dr. Alfred Swanson. The Company has the exclusive rights to use the surgeon's
name and patents.
Most of the small joint orthopaedic implants being distributed by the
Company are manufactured using solid silicone elastomers (known for their
fatigue strength, tear-resistance and biocompatibility), and titanium that is
used to manufacture protective sleeves (grommets) for some of these implants.
The balance of such small joint orthopaedic implants are manufactured primarily
from titanium and are commonly used in more active patients. Key small joint
products include:
Hand Implants. Flexible one-piece hand implants are designed to
help restore function to damaged or diseased small joints within
the hand. Key hand implants include the Swanson Flexible Hinge
Finger Joint with grommets, the Swanson Titanium Basal Thumb
Implant and the Swanson Trapezium Implant.
Wrist Implants. Wrist implants are designed to restore the
anatomical relationship of the joint connecting the wrist and the
hand. Wrist implants include the Swanson Wrist Joint Implant
with grommets, the Titanium Lunate Implant and the Titanium
Scaphoid Implant.
Foot Implants. Foot implants are designed to replace damaged or
diseased small joints found within the foot. Principal products
include the Swanson Titanium Great Toe Implant, the Hammertoe
Implant, the Swanson Flexible Hinge Toe Implant with grommets and
the Smith STA-Peg.
Elbow Implants. The Company recently introduced the Sorbie- Questor(R)
Total Elbow System. The elbow's design promotes accurate joint
tracking, proportionate distribution of load forces between the
humerus, ulna and radius and the replication of the elbow's natural
anatomic structure. The unique instrumentation enhances results. This
device was developed in cooperation with Charles Sorbie, M.D., a
well-known Canadian orthopaedic surgeon and inventor.
The Company also introduced the Swanson Titanium Radial Head implant,
an alternative to its silicone elastomer radial head implant. The
implant is manufactured from commercially pure titanium that features
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nitrogen ion implantation for increased surface hardness. The overall
profile of the implant head is unchanged from the silicone radial head
implant design.
Shoulder Implants. Shoulder implants are designed to replace the
articulating surfaces of the shoulder joint damaged principally as a result of
osteoarthritis and trauma. The Company distributes the Neer II and Modular
shoulder prostheses manufactured by the 3M Corporation.
Trauma. Trauma implants encompass a wide variety of screws, plates,
rods, wires, cables and pins all utilized to fix or support bone that has been
fractured due to accidental or surgically induced trauma. These devices serve to
orient and stabilize bone until healing can occur. The CONCISE(TM) Compression
Hip Screw System and the companion Medoff Sliding Plate enable the orthopaedic
surgeon to treat most types of proximal and supracondylar femoral fractures. The
TYLOK(TM) High Tension Cerclage Cabling System is used for fixation and
stabilization of long bone fractures and offers distinct advantages over the
competitive devices. The stainless steel CANNULATED PLUS(TM) Screw System is
used for stabilization of fracture fragments. The Company expects to introduce
in the third quarter of 1997, the first components (a femoral nail) of its
Magellan(TM) Intramedullary Nailing System, a unique modular nailing system
which allows for significant inventory reduction compared to other nailing
systems and a unique targeting device for placement of distal screws which
obviates the need for extended x-ray exposure for both physician and patient
in locating the distal screw holes in the nail.
Arthroscopy. Arthroscopic products are a combination of both implants
and instrumentation that are utilized through small incisions in conjunction
with visualization (miniature cameras) to repair damaged muscles, tendons,
ligaments or other connective or joint tissues. The Company does not offer and
has no plans to offer the cameras and visualization systems that are routinely
used in arthroscopic procedures. Rather, it has determined to concentrate on a
limited line of innovative instrumentation to address problems in arthroscopy.
The Company entered the arthroscopy market in 1995 and has since introduced
several new products. The QUESTUS(TM) LEADING EDGE(TM) Sheathed Knives including
the unique Grasper Cutter Knife, are a system of disposable sheathed knives that
allow precise resection of damaged tissues while greatly reducing the chance for
injury to normal structures.
The ANCHORLOK(TM) Soft Tissue Anchors are used in a variety of joints
for reattaching ligaments and tendons (or other soft tissue) to bone where
tearing or separation has occurred. The Company's anchors have a patented
self-tapping thread, superior holding strength and can be removed easily giving
the surgeon more surgical options. The Company plans to introduce in 1997 the
ANCHORLOK(TM) RL Soft Tissue Anchor, a lower cost version of the device which is
not prethreaded with sutures.
The Company will also commence clinical evaluation in 1997 of a unique
instrumentation system for repair of the anterior cruciate ligament damage for
which is the most common orthopaedic injury to younger patients.
Spine. The Company entered the spine instrumentation market in 1995
with the domestic and international introduction of the WRIGHTLOCK(TM)
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posterior fixation system. The patented system, under license from Zimmer, Inc.,
is indicated for scoliosis and spinal instability, and is based on a high
strength, stainless steel rod technology with Morse-taper locking mechanisms
that provide a low-profile system. The profile (i.e. the height of the implant)
can be important in the scoliosis market that principally affects teenaged and
preteenaged girls.
The Company has also received FDA clearance for its VERSALOK(TM) low
back fixation system and began marketing the product on a limited basis. Working
with a select group of spine surgeons, including innovators such as John R.
Johnson, M.D. and David Selby, M.D., the Company developed this surgeon friendly
low back fixation system that features a revolutionary polyaxial screw with a
locking design with no set screws and no locking nuts. The Company plans a full
introduction of its VERSALOK(TM) low back fixation system in 1997.
In late 1996 the Company entered into an exclusive agreement with Gary
K. Michelson, M.D. to develop an anterior cervical plating system. Michelson, an
innovative spinal surgeon and inventor, is well known as a developer of many
successful spine products. Michelson's plates, used to help fuse the cervical
vertebrae, are designed to be more anatomically correct than current plate
options. The system will utilize self tapping screws, eliminating the need for
drilling or tapping. The Company plans to commercially introduce the Michelson
plating system, pending FDA clearance, in 1997 - entering the Company into an
$87 million dollar worldwide cervical spine plate market.
Biologic Product Opportunities
Because the Company's business strategy is to identify and develop
unique solutions to orthopaedic problems, the Company continues to spend
substantial resources in the development of biologic products.
Calcium Sulfate Bone Void Filler. In late 1996 the Company acquired the
biomaterials business of USG. The business includes patents, technologies and
proprietary processes related to the use of medical grade calcium sulfate
(gypsum) in the human body. Prior to the acquisition, the Company worked closely
with USG as a licensee and exclusive orthopaedic distributor of their
bioresorbable calcium sulfate materials. Under the terms of the acquisition, the
Company will continue to purchase the medical grade calcium sulfate raw material
from USG, but will now own the proprietary process and technology necessary to
create calcium sulfate products for biomedical applications. USG spent twelve
years researching and developing gypsum opportunities in the biomedical market.
While they are a world leader in the gypsum industry, the Company believes it
has better capabilities to fully commercialize this unique technology for
biomedical applications. The Company recently received FDA clearance to begin
selling OSTEOSET(TM) bone void filler, its first calcium sulfate-based product.
OSTEOSET(TM) is the Company's first entry into the bone graft market,
which is approaching one-half billion dollars annually. The Company plans to
offer other biological skeletal repair products in the near future. OSTEOSET(TM)
is currently offered in an "off the shelf" sterile pellet form.
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Other configurations are currently under development and should soon be
available to the market.
Bone is the second most implanted material in the body (after blood
transfusions) and more than 300,000 bone graft procedures are completed annually
in the United States. Bone grafts are used to repair bone defects caused by
surgery, tumors, trauma, implant revisions and infections, and also for joint
fusion.
The preferred method of treating bone voids involves the use of any
autologous graft, in which bone is taken directly from the patient. This graft
usually achieves good results, yet often requires a second surgery site to
retrieve the graft. This second harvesting site is not only costly and time
consuming, but can also be more painful to the patient than the primary
procedure.
Currently, the second most common bone graft alternative is an
allograft from a human bone bank which generally achieves favorable results.
This tissue has limited applications because of availability and, unless it is
demineralized, it does little to induce new bone growth. The possibility of
viral disease transmission is also a concern even though the risk has been
reduced by sophisticated testing.
The third alternative for a bone graft procedure is the use of
artificial substitutes. The two types of substitutes currently on the U.S.
market are a coral-based product and a bovine collagen-based product. These
substitutes provide a matrix in which bone can grow, but these types of implants
may remain unchanged within the patient's body for an extended period of time
and in some cases may result in tissue irritation.
Compared to the current alternatives, OSTEOSET(TM) products provide an
ideal bone void filler for many bone grafting procedures because they are
biocompatible and bioresorbable. As a bioresorbable material, the body will
resorb this natural substance and will do so at a rate comparable to the
patient's new bone growth, which takes an average of four to eight weeks.
OSTEOSET(TM) material has also been shown to have osteoconductive properties.
This means that this material allows or encourages cells to generate bone in and
on its surfaces, thus furthering the effectiveness of this material as a bone
void filler. Another benefit is that the pellets can be seen on the x-ray and
become their own radiographic marker to follow the course of resorption and
replacement of the graft by new bone.
The properties of OSTEOSET(TM) bone void filler make it attractive for
use in children and for infected sites. Because children do not have as much
available bone stock as adults, the surgeon may not be able to harvest enough
bone from the child and may need to add a substitute. Medical grade calcium
sulfate pellets are ideal for this purpose. Patients who have bone infections
will also benefit from OSTEOSET(TM)'s ability to be resorbed by the body. Other
bone graft substitutes which remain in the body for an extended period may serve
as agents or hosts to prolong the infection. Since OSTEOSET(TM) pellets totally
resorb in four to eight weeks post-operation, there is nothing on which the
infectious agents may reside or bind.
The Company is also developing additional applications for its
OSTEOSET(TM) products. Pending longer-term FDA approvals and approval in
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foreign countries, OSTEOSET(TM) products may be mixed prior to implantation with
the appropriate drugs (which would then be delivered locally as the product
resorbs) such as antibiotics to be used to treat deep bone infections
(osteomyelitis), anti-neoplastic drugs to treat bone tumors or simply to deliver
medication to control pain. Presently, bone infections are treated by mixing
antibiotics with beads of polymethylmethacrylate bone cement that are then
implanted inside the bone at the site of the bone infection. This is not an
ideal treatment method, both because the bone cement ceases to release
antibiotics in therapeutic doses within 72 hours after implantation (whereas
treatment of a bone infection often requires six or more weeks of antibiotic
treatment), and because the bone cement must eventually be removed from the
infection site. The Company's research has shown that the calcium sulfate beads,
impregnated with antibiotics, release the antibiotics over a multi-week period,
in steady therapeutic doses, while the calcium sulfate is resorbed.
OsteoBiologics Implants. OsteoBiologics, Inc., a San Antonio, Texas
based company in which the Company has an ownership interest as well as
distribution rights to certain orthopaedic products, is developing a series of
bioabsorbable, polylactate and polyglycolic acid implants that, pending FDA
approvals, may be effective in a variety of uses including: as a bone growth
stimulant to aid spinal fusion; as a bone void filler; as a method to induce the
repair of articular cartilage defects (both focal defects and for resurfacing)
by growing articular cartilage in vivo; as a treatment for delayed unions and
non-unions in fractures; and the repair of bone voids resulting from tumor and
cyst removal and from thinning bone. OsteoBiologics intends to seek regulatory
approval for its first commercial products, the bone void fillers, in 1997.
OsteoBiologics also has a unique patented electronic instrument for measuring
the physical characteristics of soft tissue such as cartilage which employees a
reusable, sterilizable electronic hand piece and disposable probes. This product
is expected to be available for commercial distribution by the Company late in
1997.
Collagen based Tissue Engineering. The Company entered into a joint
venture agreement in mid 1996 with Tissue Engineering, Inc. ("TE Inc.") a
Boston, Massachusetts company that develops collagen-based scaffolds used for
ligament and tendon reconstruction and for cartilage regeneration. The Company
is also developing a calcium phosphate based bone cement which offers great
strength for fracture fixation and anchoring certain implants. The joint venture
company, Orthopaedic Tissue Technology, L.L.C., a Delaware limited liability
company, will develop and distribute biological products for musculoskeletal
applications. The initial technology is designed to reproduce the events of
tissue formation. Applications will include the treatment of medical conditions
involving disease, injury or deterioration of ligaments, tendons, cartilage or
bone and sports related injuries. Bioskeletal repair is a new segment of
orthopaedics that offers less invasive treatments for musculoskeletal injuries
and defects. Orthopaedic Tissue Technology expects to begin trials of its first
products, a biologically engineered ligament and a resorbable bone cement, in
1997.
Marketing and Distribution
Overview and U.S. Marketing and Distribution. The Company markets its
products in the United States through a network of 188 sales personnel,
including 47 distributors (the "Distributors") and 141 commissioned sales
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representatives (collectively, the "Sales Organization"), serving every state in
the country. The Distributors, who are mostly independent contractors, and the
sales representatives sell the Company's orthopaedic implants at commission
rates that the Company believes are competitive with those paid by other
orthopaedic manufacturers.
In early 1997, the Company purchased the assets of one of its
distributors, Outcome Medical, Inc., and its related companies ("OMI"). Those
related companies included two of the largest distributors of spinal devices for
one of the Company's competitors in the spinal device market, Sofamor-Danek. The
Company agreed to pay OMI for its assets over a three year period based in part,
and contingent upon, the achievement of certain sales goals in the territory. In
addition, the Company contracted with all of OMI's salespeople and has provided
them with guaranteed commissions based upon sales goals. The Company believes
that this transaction will give further support to the Company's expected growth
in sales of its spinal devices.
Management believes that the Distributors and their surgeon
relationships are a critical component of the Company's success. For
distribution purposes, the Company divides the domestic market geographically
into 46 territories, each of which is controlled by a Distributor or
Distributors authorized to sell the Company's products.
The success of these sales professionals depends primarily upon
high-quality service levels, technical proficiency and strong surgeon
relationships. As such, the Company's Sales Organization undergoes significant
product and sales training with courses conducted throughout the year.
The Company historically has focused its marketing efforts in the
United States, with approximately 75% of the Company's revenue derived
domestically over the past three years.
International Marketing and Distribution. The Company's international
sales revenue represented approximately 25% of the Company's overall sales for
1996. Management intends to continue to expand its international distribution
and marketing capabilities. The Company's international marketing and
distribution is accomplished primarily through independent distributors engaged
in distribution in Japan, South and Central America, Australia, Europe and Asia,
with the Company distributing products in France and Canada through wholly owned
subsidiaries. Depending on the market size and conditions, the foreign
independent distributors are granted either exclusive or non-exclusive rights to
distribute the Company's products, with a majority being exclusive distributors.
Competition
The orthopaedic implant industry is highly competitive and dominated by
a number of large companies with more resources than the Company. Competitive
factors include service, product design, depth of product offering, physician
recognition and price. The Company believes its future success will depend upon
its ability to be responsive to the needs of its customers and on continued
improvement and development of novel products designed not only to create better
solutions to orthopaedic problems, but
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also to solve previously unaddressed orthopaedic problems. The Company
believes the majority of the market share for the Company's products are
held by Biomet, Inc., Zimmer, Inc. (a subsidiary of Bristol-Myers Squibb
Company), Johnson & Johnson Professional, Inc. (a subsidiary of Johnson &
Johnson), Howmedica, Inc. (a subsidiary of Pfizer Inc.), DePuy (a subsidiary
of Corange), Smith & Nephew Orthopaedics, Inc. (a subsidiary of Smith &
Nephew Ltd.), Osteonics, Inc. (a subsidiary of Stryker Corporation), Sofamor
Danek Group, Inc. and Sulzer Orthopaedics, Inc. (a subsidiary of
Sulzermedica).
With respect to large joint implants (hips and knees) the competitors
listed above represent approximately 94% of the hip implant market and 92% of
the knee implant market. In addition, there are several manufacturers that
compete only in the global small joint orthopaedic implant market. The Company's
most significant competitor in this market has less than a 10% market share.
Manufacturing and Quality Control
Almost all of the Company's orthopaedic implants and instruments are
manufactured at its headquarters in Arlington, Tennessee, and through a select
group of qualified contract manufacturers. The Company's manufacturing
operations are subject to Good Manufacturing Practices ("GMP") and other
regulations stipulated by the FDA and other relevant regulatory organizations,
such as the Environmental Protection Agency ("EPA") and Occupational Safety and
Health Agency ("OSHA"), and similar state and foreign agencies and authorities.
In early 1997, the Company's facilities were inspected and cleared for GMP
compliance by the FDA.
In December of 1995, the Company's research and development,
manufacturing, and distribution operations became certified to the standards
established by the International Standards Organization ("ISO"). This "ISO 9000"
certification and process assures a level of product quality by regulating the
processes of product development and manufacturing. Approximately 80 countries
have currently adopted ISO 9000 for medical products, thereby enabling ISO 9000
registered companies to sell their products in these countries without the
additional burden of individual country regulation. Manufacturers so certified
are recognized by the European Economic Community as maintaining high levels of
quality in products and service and their products are granted the CE mark which
permits their importation into and sale within the European Economic Community.
The renewal of ISO certification occurs annually via an on-site inspection by an
authority of the European Economic Community. The Company retained ISO
certification after the 1996 audit and has applied CE marks to many key
products.
The Company utilizes comprehensive, integrated systems for
manufacturing, planning, scheduling, in-process testing, inspection and
measuring of all implants and components. The Company's current facilities have
sufficient capacity to meet its projected, near-term growth of its orthopaedic
implant and instrument business.
Government Regulations
The Company and substantially all of its products are subject to the
provisions of the Federal Food, Drug and Cosmetic Act of 1976, as amended by
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the Medical Device Amendments of 1976 and the Safe Medical Device Act of 1990,
as amended in 1992 (the "Safe Medical Device Act"). The Company also is subject
to various foreign laws governing medical devices. All of these regulations are
designed to ensure the safety and effectiveness of medical devices. In addition,
certain of these regulations require the Company to maintain certain standards
and procedures with respect to the manufacturing and labeling of products. All
of the Company's records and manufacturing facilities are subject to inspection
on a regular basis by the FDA. The Company's facilities were inspected by the
FDA in early 1997. The different levels of FDA compliance include: Official
Action Indicated (OAI), Voluntary Action Indicated (VAI), and No Action
Indicated (NAI). Companies that receive an OAI may have official action taken
against them including product approval delays, products taken off the market,
seizing of their products, heavy fines or imprisonment. Companies that receive
VAI have voluntarily agreed to correct any problems the FDA has found. The
Company fit into the NAI category which means that the FDA inspectors had
confidence that the Company is manufacturing its products within GMP guidelines
and saw complete regulatory compliance within the Company.
The FDA classifies medical devices as Class I, II or III. Class I
devices generally do not require pre-marketing approval. In general, Class II
and III devices require pre-market FDA approval unless they are found to be
"substantially equivalent" to products already in the market. For "substantially
equivalent" products, the provisions of Section 510(k) of the Federal Food, Drug
and Cosmetic Act provide for an exemption to the pre- market approval process.
The Company's orthopaedic implants are generally Class II devices. All of the
Company's Class II devices being marketed are cleared for marketing under the
provisions of Section 510(k). The Company currently manufactures no approved
Class III devices, which require more extensive FDA approvals. However, as the
Company designs and develops more novel medical devices, the Company may have
difficulty in establishing that such device is "substantially equivalent" to
another legally marketed device and thereby may be unable to obtain 510(k)
clearance to market a new product. The Company intends to pursue the manufacture
of Class III devices, which would require extensive FDA pre-market approval
before commercial distribution. There can be no assurance that the Company would
be successful in obtaining regulatory approval of such Class III devices.
At any given time, the Company has a number of medical devices that are
in various stages of development, and therefore, subject to FDA clearance
procedures that may cause delays in the commercialization of these devices. Any
future devices developed by the Company are likely to be subject to FDA
registration, notification, pre-market approval, performance standards or other
FDA controls that could have an adverse effect on the commercialization of such
products. Additionally, any changes in FDA or foreign medical device laws could
impose new regulatory burdens on medical device sales.
During 1996 the Company received 510(k) clearance on 14 new products.
In addition, the Company received regulatory approval (SHONINS) in Japan to
distribute key products. The Company also enhanced its quality control process
by establishing a pre-production quality assurance program. The Company
converted to the new GMP standards and to the new Medical Device Reposring
regulations. No product recalls were experienced during 1996.
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The Safe Medical Device Act grants the FDA the authority to require
manufacturers to conduct post-market surveillance on most permanent implants and
devices that potentially present a serious risk to human health. The FDA is also
given the authority to require manufacturers of certain devices to adopt device
tracking methods to enable patients to receive required notices pertaining to
the devices they receive. Such tracking requirements may increase the Company's
administrative procedures relating to the sale of many of the Company's implants
should the FDA require post-market surveillance of the Company's products.
Despite the fact that the FDA has not yet promulgated all of the regulations
needed to fully implement the Safe Medical Device Act, the Company does not
believe compliance with that act will have a material adverse affect on the
Company or its operations.
Research and Product Development
The Company's research and development activities and capabilities are
located primarily in Arlington, Tennessee. There is a small development activity
for arthroscopy products at Questus Technologies, Inc. in Marblehead,
Massachusetts and a small development activity for the medical grade calcium
sulfate products in Libertyville, Illinois. Both are in leased space. Over 78
employees are active in the areas of Applied Research, Biomechanical
Engineering, Materials Testing and Analysis, Advanced Manufacturing Technology,
Implants and Instrument Development Techniques, Research, Product Development
and New Technology Exploration. The Company's applied technology group maintains
laboratories capable of performing materials characterization, product testing
and evaluation in simulated clinical use environments, including fatigue
testing, wear testing and materials analysis.
In addition to classic laboratory testing and evaluation of new
products and technologies, the Company conducts pre-clinical studies at a number
of university and medical center locations, as well as clinical research to
evaluate the success and outcome of new products and technologies. The Company
maintains consulting relationships with over 40 individuals and has active
testing or evaluation programs at 10 research institutions.
The Company believes that custom implants built to prescription from a
surgeon, serve as a specific treatment for a patient, but also help to explore
new and innovative products for general use. For example, initially designed as
a custom implant for limb salvage, the Company's S.O.S.(R) (Segmented
Orthopaedic System) now has wide spread application for oncology patients and
severe revision cases. During 1996 the Company shipped approximately 250
individual patient devices, with an average time of manufacture of less than 20
days. In addition to custom implants, the Company provided surgeons with many
options for custom instrumentation to facilitate their surgical techniques.
In 1996 the Company created a biological products development group
within its research and development area to focus on biological products.
Major products that the Company believes will be introduced in 1997
are:
The MAGELLAN(TM) Femoral Nail which has both an innovative product
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design, including proximal modularity, and a breakthrough targeting
device for the distal interlocking screws that does not require an
x-ray or C-arm fluoroscope procedure. Tibial and Humeral nails for the
system are expected to be launched late in 1997.
The Orthomatrix(TM) External Fixator for the distal radius and
hand area, with a fracture alignment table to facilitate reduction of
the fractures and assist in alignment of the bones.
A tri-modular shoulder that will allow broader based
indications in trauma and revision shoulders and greater flexibility
for the surgeon to match the implant to the patients needs.
The TRANSCEND(TM) Hip System incorporating alternative bearing
surfaces in the total hip area including metal-on-metal and ceramic-on-
ceramic combinations. An IDE study on ceramic-on-ceramic is anticipated
to commence in 1997. Clinical study of the metal-on-metal total hip
product is also expected.
The CONSERVE(R) Hip System for resurfacing the femoral head of
patients thereby delaying the time when a total hip arthroplasty is
required.
A new PCL Sparing ADVANCE(TM) Knee, a Medial Pivot ADVANCE(TM)
Knee and the development for evaluation of a Mobile Bearing Knee.
An Anterior Cervical Plate System and the Intervertebral Spacer.
The Actalon(R) Probe soft tissue measuring device.
Osteoset T(R) bone void filler pre-mixed with tobramycin.
The Company's commitment to research and development is evidenced by
the expenditures it makes each year. Research and development expenses were
approximately $15.1 million in 1994, approximately $12.7 million in 1995, and
approximately $13.2 million in 1996, which the Company believes represents a
commitment which is significantly higher as a percentage of sales than all of
its major competitors.
Principal Customers
The Company currently markets its products to health care professionals
and hospitals in the United States and in many major countries outside of the
United States. Key customers include orthopaedic surgeons specializing in total
joint replacement, sports medicine, spinal surgery and traumatology. The Company
has approximately 4,800 active hospital and physician customers, with no single
customer representing more than two and one-half percent of the Company's
consolidated sales. The Company currently does not conduct any business directly
with foreign governments, with such sales being made through the Company's
established distribution network of independent contractors.
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Raw Materials
The majority of the Company's raw material purchases are comprised of
four principal materials that are generally available, in implant grade, from a
variety of sources with various lead times. Cobalt chrome is purchased in ingot
form and cast into implants and trials. Titanium, both commercially pure and
alloy grade, is purchased in bar stock form and machined into implants and
instruments. Ultra high molecular weight polyethylene, also purchased in bar
stock form, is machined into implants for weight bearing and articulating
surfaces. Stainless Steel 17-4 precipitation hardened is purchased in both ingot
and bar form and is cast or machined into instruments, and stainless steel
22-13-5, 22-13-10, and 316L is purchased in wrought bar form that is machined
into implants. In addition, the Company's small joint implants require silicone
that is purchased as processed extruded elastomer blocks.
The Company has not experienced a shortage of raw materials and does
not anticipate a shortage in the future. In light of certain business'
increasing reluctance to offer raw materials intended for medical devices
because of product liability concerns, there can be no assurance of continued
supply or that finding an alternative source would not cause a delay in the
Company's manufacturing process.
Environmental
The Company believes it is operating in material compliance with
applicable regulations required by the State of Tennessee and the EPA. The
Company's objective is to operate in a clean and safe environment, minimize the
generation of hazardous and non-hazardous waste and promote environmentally
sound recycling, reuse and reclamation of waste. As part of the Company's
recognition of resource protection, its level of recycling has been increased.
The Company does not expect to incur a material amount of capital expenditures
in order to maintain its environmental compliance. Furthermore, the Company
believes that compliance with these regulations will not materially impact
either the Company's earnings or competitive position.
Insurance
The Company maintains comprehensive and general liability insurance,
including product liability, with coverage up to $100,000,000 in the aggregate.
The Company maintains a $250,000 per incident and $750,000 aggregate self
insured retention. Although the Company has not experienced any significant
claims to date, there can be no assurance that the Company's insurance will be
adequate to cover any claims that may be asserted in the future. Although Dow
Corning Corporation has contractually agreed to indemnify the Company for all
products manufactured by Dow Corning prior to the Acquisition (other than
certain small joint implants purchased by the Company and sold after the
Acquisition), there can be no guarantee that such indemnity will continue in
light of Dow Corning's bankruptcy filing; the Company does not maintain
insurance for those claims.
The Company also maintains liability insurance covering directors and
officers with coverage up to $5,000,000. There is no deductible per officer or
director per event and a $100,000 deductible for the Company per event.
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The Company also carries insurance coverage for all real and personal property
including business interruption, and coverage for workers' compensation, crime
and fiduciary liability in amounts that management believes to be adequate.
Patents and Trademarks
As of March 10, 1997, the Company owned or held licenses for 151 issued
patents and had applications pending in the United States and major countries
throughout the world for eight additional inventions. The Company has purchased,
licensed or has distribution rights for the design, manufacture and distribution
of certain products. See "Business--Principal Products." The Company currently
has 29 registered trademarks and applications pending on 18 other marks in the
United States and major countries throughout the world. The Company uses its
patents and trademarks throughout the world in connection with its business
operations. As necessary, the Company vigorously protects its patents and
trademarks both domestically and internationally.
Royalty and Other Payments
The Company has various agreements with unaffiliated entities and
persons that provide the Company with certain rights to manufacture and market
certain orthopaedic products developed independently by such entities or persons
or jointly with the Company. The agreements provide for royalty payments ranging
from less than 1% to 10% of the net selling price (as defined in such
agreements) of those certain orthopaedic products. In addition, the Company has
a number of consulting agreements pursuant to which distinguished surgeons
evaluate the Company's new and existing products in exchange for a consulting
fee.
Seasonality
The Company's revenues are subject to some seasonality. Since the
majority of implant surgery is elective, the warm weather months traditionally
yield lower sales volumes than do the late fall and winter months.
Employees
As of March 10, 1997, the Company had 609 full-time employees,
including 571 at its Arlington operations, 8 in regional operations and 30
outside the United States. The Company's employees are not covered by any
collective bargaining agreements. The Company believes that its relationship
with its employees is good.
ITEM 2. PROPERTIES.
The Company's headquarters and manufacturing operations are located in
leased facilities in Arlington, Tennessee, which is located near Memphis. The
Company's facilities consist of an aggregate of approximately 168,000 square
feet, approximately 53,000 of which are utilized for manufacturing
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and approximately 45,000 of which are utilized as a distribution center with the
balance being utilized for office space.
The acquisition and construction by the lessor of the Company's
manufacturing facilities were financed through the issuance by the lessor of
industrial development bonds, which have been paid in full. The base rent
payable under the lease for the initial term was the amount required to meet the
debt service requirements of the bonds. Accordingly, no further base rent is
payable during the initial term of the lease. The initial term of the lease
expires in 1999. The Company has the option to renew the lease for five
additional ten year terms at a base rental of $6,000 per year. In addition, the
Company has the option to purchase the facilities at a price of $100 at any time
prior to the expiration of the lease in 1999.
The lease for the Company's office facilities provides for the payment
of annual rent of $5,000, plus the lessor's expenses. The term of the lease
expires in 2005. The Company has the option to purchase the facilities at a
price of $101,000 at any time prior to the expiration of the lease in 2005.
The acquisition and construction by the lessor of the Company's
distribution center was also financed through the issuance by the lessor of
industrial development bonds, which have also been paid in full. The base rental
under the lease was the amount required to meet the debt service requirements on
the bond. Accordingly, no further base rent is payable during the term of the
lease. The term of the lease expired on the original maturity date of the bonds.
The Company has the option to purchase the facilities at a price of $1,000 at
any time. The Company added 5,000 square feet as an extension to the original
distribution center structure during 1995.
The Company leases approximately 4,000 square feet in Marblehead,
Massachusetts for its Questus facility that provides for monthly rent of
$10,860. The initial term of the lease expires in October 1997 and the Company
expects to be able to renew said lease on favorable terms. The facility is used
for research and development and office space.
ITEM 3. LEGAL PROCEEDINGS
DCW, pursuant to the Acquisition agreements, retains liability for
matters arising from certain conduct of DCW prior to the Company's acquisition
on June 30, 1993, of substantially all the assets of the large joint orthopaedic
implant business of DCW. As such, DCW has agreed to indemnify the Company
against all liability for all products manufactured prior to the Acquisition
except for products provided under the Company's 1993 agreement with DCW
pursuant to which the Company purchased certain small joint orthopaedic implants
for worldwide distribution. However, the Company was notified in May 1995 that
DCW, which filed for reorganization under Chapter 11 of the U.S. Bankruptcy
Code, would no longer defend the Company in such matters until it received
further direction from the bankruptcy court. On December 2, 1996 DCW filed a
proposed plan of reorganization that provides that all commercial creditors will
be paid 100% of their claims, plus interest. The plan did not however indicate
whether DCW would affirm or reject the Acquisition agreements. Accordingly,
there
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can be no assurance that Dow Corning will indemnify the Company on any claims in
the future. Although the Company does not maintain insurance for claims arising
on products sold by DCW, management does not believe the outcome of any of these
matters will have a material adverse effect on the Company's financial position
or results of operations.
On October 25, 1996, the Company was notified that it had been sued by
Mitek Surgical Products, Inc., a subsidiary of Johnson & Johnson, in the United
States District Court for the Northern District of California seeking damages
for the alleged infringement of its patent by the Company's ANCHORLOK(TM) soft
tissue anchor. The Company has denied the allegations and is defending the
action.
On April 3, 1995, the Company (and Orthomet, Inc., a wholly owned
subsidiary at the time that has subsequently been merged with and into the
Company) was notified that it had been sued by Joint Medical Products
Corporation (which was purchased by Johnson & Johnson Professional, Inc.), in
the United States District Court for the District of Connecticut seeking damages
for the alleged infringement of its patent (U.S. Pat. No. 4,678,472, the "'472
Patent") by certain of the Company's acetabular cups and liners. Pending the
resolution of an interference proceeding in the U.S. Patent and Trademark Office
regarding the '472 Patent by British Technology Group Ltd. ("BTG"), such
complaint was dismissed without prejudice. In early November 1996, the Company
was notified that the interference proceeding was resolved, and that, the
complaint has been refiled (but not served). BTG has offered the Company a
license of the '472 Patent and a corresponding reissue patent. The Company
believes that it has valid defenses to claims of infringement of the '472 Patent
and to the reissue patent.
The Company is not involved in any other pending litigation of a
material nature that would have a material adverse effect on the Company's
financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.
NONE
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PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The Company's Class A Common Stock currently is not publicly traded,
and, as such, market value quotations are unavailable. There were 400 registered
holders of Class A Common Stock as of March 19, 1997. The Company has never paid
dividends on its Class A Common Stock and does not expect to pay any cash
dividends in the foreseeable future. The Company currently intends to retain its
earnings, if any, for future operations and expansion of its business. Any
decisions as to the payments of dividends in the future will depend on the
earnings and financial position of the Company and such other factors as the
Board of Directors deems relevant. In addition, the Company's indenture with
State Street Bank and Trust Company, as successor to First National Bank of
Boston, on providing for the issuance of the Company's 10 3/4% Series B Senior
Secured Notes, due July 2000 (the "Indenture"), the Company's Restated
Certificate of Incorporation, the Company's Series B Preferred Stock Purchase
Agreement and Class A Common Stock Warrant Agreement dated as of July 29, 1994
with the California Public Employees Retirement System ("CalPERS"), as amended,
and the Class A Common Stock Warrant Agreement dated as of September 25, 1995
with CalPERS (collectively, the "CalPERS Agreement") and its Credit Agreement
dated September 13, 1996, by and between the Company and Sanwa Business Credit
Corporation (the "Credit Agreement"), substantially limit the payment of cash
dividends on the Company's capital stock.
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ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial data of DCW medical device business
(the "Predecessor") and the Company and its subsidiaries (the "Successor")
should be read in conjunction with the financial statements and the notes
thereto included in Item 8.
(in thousands, except per share data and ratio)
Predecessor Successor
Year JAN 1, JUN 30, Year Year Year
Ended through through Ended Ended Ended
DEC 31, JUN 30, DEC 31, DEC 31, DEC 31, DEC 31,
1992 1993 1993 1994 1995 1996
Operating Data:
Net sales $71,598 $35,033 $ 43,027 $ 95,763 $123,196 $121,868
Net income (loss) 5,101 437 (2,572) (49,380) (6,492) (14,589)
Loss per common share -- -- (.41) (6.10) (2.24) (3.90)
Balance Sheet Data:
Total assets $71,747 $72,691 $113,497 $154,551 $174,371 $166,326
Long term debt 243 108 84,605 84,983 84,462 84,668
Mandatorily redeemable
Series B Preferred -- -- -- 47,658 46,757 59,959
Redeemable Convertible
Series C Preferred -- -- -- -- 20,548 24,995
Parent company
investment 64,543 68,029 -- -- --
Stockholders' equity -- -- 11,602 (25,502) (25,177) (58,506)
Ratio of earnings to
fixed charges and
preferred dividends -- -- (A) (A) (A) (A)
(A) Earnings were inadequate to cover fixed charges, preferred dividends
and accretion of preferred stock by approximately $3.6 million, $61.7
million, $26.3 million, and $35.3 million, respectively, for the period
from June 30, 1993 through December 31, 1993 and for the years ended
December 31, 1994, December 31, 1995, and December 31, 1996.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
Although sales declined slightly, 1996 was a year of promising
successes as the Company continued to introduce and develop new and innovative
products, upgrade its domestic distribution, improve its international
distribution, reduce administrative expenses, hold inventories steady despite
large inventory builds for new products, and generate cash from operations in
the last five months of the year.
The Company's largest disappointment was that the expected growth in
sales failed to materialize and the sales ended the year down $1.3 million or
(1.1%) to $121.9 million. International sales were up 8.6% while domestic sales
were down 3.9%. The Company believes that this overall decline led by the U.S.
market was not inconsistent with the orthopaedic device industry in general, and
the large joint business (the sales of knee and hip prostheses) in particular.
Throughout the industry, pricing pressures from buying groups reduced unit
prices despite continued increases in unit sales growth. In addition, the trends
created by managed care initiatives, which demand lower priced implants that are
affixed with cement rather than higher priced porous coated implants, further
reduced average unit pricing. The Company suffered particularly from this trend
because the more expensive porous coated implants historically have comprised a
high proportion of its knee implant sales (76% in 1994, 70% in 1995 and 64% in
1996). Demonstrating these overall trends, the sales of the Company's knee
prostheses were down $2.0 million from the prior year despite a 2.7% increase in
unit sales.
The Company was encouraged however by its quarter to quarter sales
trends as the sales declines were experienced in the first half of the year
while third and fourth quarter sales increased over the prior year's periods. In
addition, since September, 1995 through the third quarter of 1996, the Company
added or replaced 10 of its 47 domestic distributors. While a change in
distributors often results in a short term loss of business, the Company
believes that upgrading to new distributors will positively affect the Company's
sales in the longer term. Finally, the Company believes that the changes to both
the tenor and substance of its relationship with its domestic distributors will
also positively affect sales in the longer term.
The Company was pleased with its new product development as it
continues to seek penetration into segments of the orthopaedic marketplace that
are not yet governed by the pricing and managed care pressures experienced in
the large joint markets. The Company's sales of spinal, trauma, arthroscopy and
biologics products were $3.7 million, a growth of approximately 300% over prior
year. Late in the third quarter of 1996, the Company received regulatory
approval for, and began marketing its OSTEOSET(TM) Bone Void Filler. The product
is the Company's first commercial product from its biologics development
program, and is the industry's first FDA cleared bioresorbable bone void filler.
Other products launched in 1996 included the VERSALOCK(TM) Spinal Fixation
System for lumbar spine fusions, and a posterior stabilizing version ADVANCE(TM)
Knee System, developed in cooperation with the renowned Hospital for Special
Surgery in New York City. The Company expects to generate significant sales from
these three products
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in 1997. The Company also expects to introduce in 1997 additional products in
its OSTEOSET and ADVANCE product lines, the MAGELLAN(TM) Intramedullary Nail to
address complex femoral fractures, and a novel plating system for the cervical
spine to compliment its spinal device product line.
International sales were also encouraging, increasing $2.4 million to
$30.4 million. This gain comes despite a slight decrease in sales to Japan, the
Company's largest international market. In 1996, the Company consolidated its
Japanese distribution with a single distributor, Century Medical, Inc., and
expects sales to that market to increase significantly in 1997. International
sales excluding Japan were up 13.3% over prior year as the Company continues to
devote significant resources and personnel in an effort to penetrate those
markets faster. The Company also added distributors in Italy and Korea in 1996.
RESULTS OF OPERATIONS
Year Ended December 31, 1996 Compared With Year Ended December 31, 1995
Sales. In 1996, the Company posted sales of $121.9 million representing
a net sales decrease of approximately 1.1%, or $1.3 million, compared to its
1995 sales of $123.2 million. Although sales were lower than prior year, the
trend of the Company's sales quarter-by-quarter during 1996 compared to 1995
reflects an encouraging trend. Sales in 1996 were approximately 7.2% below prior
year in the first quarter, approximately 0.3% below prior year in the second
quarter, approximately 0.4% above prior year in the third quarter, and
approximately 3.7% above prior year in the fourth quarter.
Domestic sales for the year were $3.7 million or approximately 3.9%
below 1995 while the Company's international sales grew by approximately 8.6% or
$2.4 million over prior year. Sales in Europe, Latin America, Canada, and Asia
grew by $1.6 million (approximately 13.0%),$1.0 million (approximately 56.3%),
$0.5 million (approximately 17.2%), and $0.2 million (approximately 10.1%)
respectively, offset primarily by lower than prior years' sales in Japan which
were due to prolonged transition in the change of distribution channels that was
initiated by the Company in order to better serve this market over the long
term.
Although total sales for 1996 decreased as compared to 1995, new
product line sales increased compared to prior year sales for the period in
ADVANCE(TM) Knee ($2.6 million), trauma ($0.7) million), spine ($0.5 million),
arthroscopy products ($1.0 million) and biologics ($0.3 million). Those gains
were offset by decreased sales for the period in knees, other than ADVANCE(TM)
($4.7 million), hips ($0.9 million), and small joint products ($0.9 million).
Despite the decrease in sales dollars during 1996, unit sales of the Company's
large joint products increased during 1996 when compared to 1995. In large
joints, particularly hips and knees, the Company (and management believes the
entire orthopaedic industry) experienced a shift from higher priced porous
coated products to lower priced cemented products. While selling prices
increased slightly in both cemented and porous products, the mix of sales
towards cemented designs resulted in a lower average selling price per
procedure.
194
Cost of Goods Sold. Cost of goods sold increased from $33.7 million in
1995 to $44.4 million in 1996, or approximately 32%. The $10.7 million net
increase is due to additional instrument reserving ($3.6 million) because of the
reclassification of surgical instruments to inventory as part of the Company's
revised instrument program designed to give the Company's independent
distributors better access to these instruments, increased variances charged to
cost of goods sold ($2.8 million), a reduction of the sales return reserve ($0.8
million), a higher level of sales of fully reserved products in 1995 resulting
in the reversal of inventory reserves during that year ($1.1 million),
additional product reserving in 1996 ($0.4 million) and increased manufacturing
costs ($1.8 million).
Selling. Selling expenses increased slightly in 1996 by $0.3 million
when compared to 1995. Although sales in 1996 were lower than 1995, commission
expenses, primarily guarantees, increased by $0.7 million in 1996 to $21.7
million. Royalties increased in 1996 to $2.0 million compared to 1995 royalties
of $1.4 million due largely to an increase on royalties being paid on the
Company's small joint orthopaedic products. Domestic marketing expenses
decreased in 1996 ($0.2 million) due primarily to lower literature, supplies
and advertising ($0.6 million) because of fewer new product launches in 1996
and lower travel and entertainment expense ($0.7 million) offset by increased
payments ($0.6 million) due to distributor replacements and territory
realignments and increased salaries and benefits ($0.8 million) due to
critical headcount adds. International marketing expenses decreased by $1.7
million in 1996 when compared to the same period in 1995. The reduced spending
in 1996 resulted primarily from shutdowns in Brazil ($0.5 million) and Australia
($0.2 million) along with lower salaries and benefits in France due to the
transition to a non-employee sales force ($0.5 million), and decreases in the
headquarters' expenses in salaries, benefits, and travel ($0.3 million) which
contributed to this favorable variance year over year.
The Managed Care division of the Company spent $1.3 million in 1996
which was $1.0 million more than was spent in 1995. This spending was
non-recurring as this division was closed in December, 1996.
General and Administrative. General and administrative costs decreased
from $23.4 million in 1995 to $19.4 million in 1996, or a decrease of $4.0
million (approximately 17%). This decrease was attributable in large part to
lower intangible amortization ($1.2 million), reduced travel and entertainment
expenses due to the sale of the corporate jet and reduced overall travel ($2.1
million), lower insurance costs ($0.4 million), decreased legal fees ($0.4
million) and lower outside services ($0.4 million) offset by higher salaries and
benefits due to payment of the 1996 management bonus ($1.0 million).
Additionally lower professional fees in 1996 ($0.2 million) and international
favorable variances for the period due to lower spending in France ($0.2
million) contributed to the favorable year-over-year variance.
Research & Development. Research and development expenses increased
$0.5 million from $12.7 million in 1995 to $13.2 million in 1996, or an increase
of approximately 4.0%. This increase reflects management's continuing belief
that these strategic expenditures are necessary to
195
continue the flow of new and diverse products from the Company into the
marketplace.
Other. Equity in loss of investment ($0.5 million) represents the
Company's 50% share of the expenses incurred related to the joint venture with
Tissue Engineering, Inc. discussed further in Note 2 to the Consolidated
Financial Statements. Amortization of a certain license arrangement obtained
from Tissue Engineering, Inc. ($0.3 million) was the primary contributor to the
joint venture loss.
Other income for the year ended December 31, 1996 increased $0.3
million as compared to the same period in 1995 due primarily to favorable
currency conversion. Interest expense, net of interest income, increased from
$11.3 million in 1995 to $11.9 million in 1996, an increase of $0.6 million, or
approximately 5%. This increase in interest expense was primarily due to
financing costs associated with the private placement of the Company's Series C
Preferred Stock late in 1995.
For the year ended December 31, 1996 earnings before interest, taxes,
depreciation, and amortization ("EBITDA") is detailed in the table below. EBITDA
totals both before and after certain adjustments are shown:
December
31, 1996
---------------
Operating Income $(3,055)
Depreciation and Instrument Amortization 11,272
Amortization of Intangibles 3,266
Amortization of Other Assets 266
---------------
EBITDA before Certain Adjustments $11,749
Inventory Reserves and other Related
Inventory Adjustments 4,852
Orthomet Inventory Step-Up* 992
---------------
EBITDA after Certain Adjustments $17,593
===============
* Amount represents the flow through of the purchase
accounting adjustment in 1996 as it related to
acquired Orthomet inventory.
Year Ended December 31, 1995 Compared With Year Ended December 31, 1994
Sales. In 1995, the Company posted sales of $123.2 million representing
a net sales increase of approximately 28.6%, or $27.4 million, over its 1994
sales of $95.8 million. Of this growth, $25.8 million came from the Orthomet
product lines, either acquired or expanded by the Company over the course of the
year.
196
Domestic sales increased $22.6 million, while international sales grew
$4.8 million. The Company experienced declines in the sales of its products in
Australia, Japan, and Asia as each of these regions experienced prolonged
transition in the change of distribution channels that were initiated by the
Company in order to better serve those markets over the long term. Outside of
those regions, the Company's international sales were up greatly.
The total sales increase of $27.4 million can be attributed to
increases in hip products of $13.7 million, knee products of $12.1 million,
shoulder products of $1.0 million, and the new trauma, spine, and arthroscopy
products of $1.2 million. Those gains were slightly offset by non-recurring 1994
sales of discontinued DCW products. While management believes that unit sales of
its large joint products have increased (using estimates for the full-year 1994
Orthomet performance), a clear shift to lower priced cemented products was
experienced in both its hip and knee business. While selling prices increased in
both cemented and porous coated products, the mix of sales towards cemented
designs resulted in a lower average selling price per procedure when compared
to prior year.
Cost of Sales. Cost of sales decreased from $43.6 million in 1994 to
$33.7 million in 1995, or approximately 22.7%. The $9.9 million net decrease is
a net result of a $7.8 million increase due to volume increases, 1994 inventory
reserve adjustments which increased 1994 Cost of Sales by $12.1 million which
did not occur in 1995, a $3.4 million decrease principally related to the 1995
sale of previously reserved inventory as well as $2.2 million of other
decreases. In 1994, reserves were established for certain products that the
Company did not expect to remain viable in 1995, because of the acquisition of
the Orthomet products and the decision to cease gamma radiation of implants in
favor of ethylene oxide gas technology. However, some of these products have
continued to be sold in 1995 resulting in the reversal of previously established
inventory reserves and thus favorable reserve adjustments.
Selling. Selling expenses increased $13.9 million from $33.2 million in
1994 to $47.1 million in 1995, or approximately 41.7%. Selling expense increases
associated with 1995 sales volume increases were estimated at $5.3 million, with
the Company spending approximately an additional $1.0 million in selling
expenses related to Orthomet-to-Wright transition costs and sales force
consolidation costs. In addition to these volume-driven or
transition/consolidation costs, selling expenses also increased domestically by
approximately $3.1 million due to staffing and other increases related to the
Company's initiatives into the new markets of trauma, spine, and arthroscopy.
International selling expense increased $2.7 million (excluding $0.6 million of
instrument amortization) led by increases at headquarters and in Europe as the
Company began to invest in infrastructure additions to service European markets
outside of France. Selling expenses are expected to decrease dramatically in
Australia in 1996, where early in the fourth quarter the Company began
distributing its products through a single third party distributor (Device
Technologies, Australia) and subsequently closed its sales office, and in Brazil
where the Company plans to similarly transition its distribution. Operating
expense savings from these actions will be realized in 1996. Also, global
instrument amortization expenses increased year-over-year by $1.8 million ($1.2
million domestic and $0.6 million international).
197
General and Administrative. General and administrative costs increased
from $23.3 million in 1994 to $23.4 million in 1995, or an increase of
approximately 0.4%. Increases in 1995 occurred primarily in amortization of
intangibles (largely assets acquired from Orthomet) of $2.3 million, $0.5
million of Orthomet-to-Wright transition costs, and depreciation expense of $0.6
million. These were offset by non-recurring 1994 product liability costs ($0.7
million), no management bonus expense in 1995 (savings of $1.5 million)and
savings from 1995 downsizing moves in Australia and Brazil ($0.9 million).
Research & Development. Research and development expenses (exclusive of
1994 non-recurring adjustments of $7.1 million described below) increased $4.7
million from $8.0 million in 1994 to $12.7 million in 1995, or an increase of
approximately 59.4% reflecting managements view of these expenses as strategic
investments necessary to continue the flow of new and diverse ideas and products
into the Company. This increase was primarily due to an increased number of
development consulting agreements initiated by the Company with a number of
distinguished orthopaedic surgeons and scientists to develop a new generation of
knee and hip prostheses, spinal systems, upper extremity prostheses, and
arthroscopy products.
In 1994, the acquisitions of Orthomet and Questus resulted in a
one-time write off of $27.7 million for in-process research and development. The
in-process research and development was written off immediately following the
1994 acquisition because, in the opinion of management, the technological
feasibility of the in-process technology had not yet been established and the
technology had no alternative future use. Of the research and development
projects underway at Orthomet at the point of acquisition, two have been
completed and work on three continues, which management expects to become
commercially viable over the course of the next three years. Five additional
acquired projects or technologies either have been divested, canceled, or merged
into similar technology efforts underway at the Company.
An additional $7.1 million of contractually obligated costs associated
with product development efforts and contracts with ABI, U.S. Gypsum, and
OsteoBiologics were also recognized in research and development expense in 1994.
These costs did not recur in 1995.
Other. Non-operating expenses decreased $1.0 million from $0.9 million
in 1994 to $0.1 million (income) in 1995 due primarily to the write off in 1994
of certain non-operating receivables. Interest expense, net of interest income,
increased from $9.2 million in 1994 to $11.3 million in 1995, an increase of
$2.1 million, or approximately 23%. This increase in interest expense was due
primarily to interest charges associated with the Company's increased
utilization of its revolving line of credit as well as amortization of deferred
financing costs associated with the private placement of the Company's Series C
Preferred Stock.
LIQUIDITY AND CAPITAL RESOURCES
Since the Acquisition, the Company's growth strategy has been to
position itself for the future through new product development and the
acquisition of new technologies through license agreements, joint ventures
198
and purchases of other companies in the orthopaedic field (see Note 2 to the
Financial Statements). The Company's needs for capital have been funded through
the sale of $85 million of senior debt securities and the contribution of
approximately $15 million of equity at the time of the Acquisition. Further, the
Company has obtained additional capital through the issuance of Series B
Preferred Stock in July 1994 to CalPERS ($60 million), through the issuance of
Series C Preferred Stock to Princes Gate Investors, L.P. and affiliates, in
September 1995 ($35 million) (see Note 8 to the Financial Statements), and
through the use of revolving lines of credit (see Note 7 to the Financial
Statements).
The Company had available to it a $30 million revolving line of credit
under the Heller Agreement that expired in September, 1996. The Company's
projected cash flow requirements for 1996 due to continued growth and
development of new products, indicated that a similar revolving credit agreement
was needed to fund the working capital needs of the Company going forward.
Management negotiated with several financial institutions and on September 13,
1996 finalized and closed an agreement for a loan and security agreement with
Sanwa Business Credit Corporation for a $25 million revolving line of credit
(which can increase to $30 million with the occurrence of certain events) that
expires in September, 1999. As of December 31, 1996 this agreement provided an
eligible borrowing base of $19.4 million. As of March 17, 1997 this agreement
provided an eligible borrowing base of $21.5 million and the Company had drawn
$16.3 million under this agreement. During 1996 borrowings under the Heller and
Sanwa Agreements averaged $12.5 million with a maximum amount borrowed of $16.1
million, as compared to 1995 when borrowing averaged $15.1 million and reached a
high of $29.0 million. The Company believes that the Sanwa Agreement will be
sufficient to meet its working capital needs for 1997.
The Company's capitalization includes senior debt securities of $84.4
million and Series A, B, and C of preferred stock with an aggregate liquidation
value of $140.6 million including accrued dividends of $18.0 million at December
31, 1996. These securities currently bear interest or dividend rates ranging
from 10.8% to 16.9% and, in certain circumstances, these rates can increase to
21.4%. As a result of the Company's obligations to establish a sinking fund for
its senior debt securities beginning in July, 1998 ($28.3 million) and its
obligation to issue additional warrants to acquire common stock in the event
that the Series C Preferred Stock is not redeemed or there has not otherwise
been a qualified initial public offering on or before March, 1999, management
believes that the Company will be required to effect a recapitalization plan to
satisfy these future obligations. In this regard, the Company has begun
discussions with a limited number of investment banks to discuss the various
alternatives available to the Company, including without limitation, refinancing
the Senior Secured Notes. Management believes that a successful plan of
recapitalization will be completed prior to the sinking fund payment becoming
due in July, 1998, however, there can be no assurance that such a refinancing or
recapitalization plan can be consummated.
At year end 1996, the Company had approximately $1.6 million in
outstanding capital commitments, and has budgeted approximately $4.3 million for
1997 expenditures for the purchase of machinery and related capital equipment.
199
As of December 31, 1996 the Company had net working capital of $50.5
million, compared with $45.2 million as of December 31, 1995. Of this $5.3
million growth, $4.3 million was attributed to growth in inventory due primarily
to the reclass of surgical instruments to inventory from property, plant and
equipment, $3.6 million was due to the net change in deferred income taxes in
1996 and $1.7 million was due to decreases in accounts payable. Offsetting these
charges were increases to accrued expenses and other current liabilities ($0.9
million) primarily due to U.S. Gypsum (see Note 11 of Financial Statements) and
Orthopaedic Tissue Technology, L.L.C. obligations (see Note 2 of Financial
Statements) and increased short-term borrowings against the revolving line of
credit ($4.5 million).
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information called for by this item is set forth in the financial
statements contained in this report on Form 10-K and is incorporated herein by
this reference. An index to the financial statements is set forth on page 53 of
this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
200
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Executive Officers and Directors
Directors of the Company are elected annually and hold office until the
next annual meeting of stockholders or until their successors are duly elected
and qualified. All officers of the Company are appointed by and serve at the
discretion of the Board of Directors of the Company. Election of directors is
governed in part by a Letter Agreement dated June 30, 1993, as amended on July
29, 1994 and as amended on November 21, 1995 between Mr. Korthoff and Kidd Kamm
Equity Partners, L.P. (the "Letter Agreement"). The following table sets forth
the executive officers and directors of the Company as of March 15, 1997.
NAME AGE POSITION WITH COMPANY
Richard D. Nikolaev 58 Director, President and
Chief Executive Officer
Lewis H. Ferguson, III 52 Director, Senior Vice President
and Secretary
George G. Griffin, CPA 49 Executive Vice President and
Chief Financial Officer
Jack E. Parr, Ph.D. 57 Executive Vice President,
Research and Development
Allen H. DeSatnick 56 President of Questus Division
Richard H. Mazza 50 Executive Vice President,
Operations
Herbert W. Korthoff 53 Chairman of the Board of
Directors
William J. Kidd 55 Director
Kurt L. Kamm 54 Director
Walter S. Henning 54 Director
Eric R. Hamburg 34 Director
Richard D. Nikolaev has been the President and Chief Executive Officer
of the Company since November 1995 and a Director of the Company since July,
1995. Prior to joining the Company, Mr. Nikolaev served as a consultant to
various medical device companies since December 1994. From January 1992 until
December 1994, Mr. Nikolaev was Chairman, President and Chief Executive Officer
of Orthomet, Inc., a NASDAQ company acquired by the Company in December 1994.
Prior to joining Orthomet, Inc., Mr. Nikolaev served as President of Orthopaedic
Synergy, an orthopaedic consulting company and as an executive officer of
various orthopaedic companies.
201
Lewis H. Ferguson III has been a Director of the Company since August
1993. Mr. Ferguson became Senior Vice President in January 1994. Prior to
joining the Company, Mr. Ferguson had been a partner in the Washington, D.C.
law firm of Williams & Connolly since 1979. Mr. Ferguson is on an extended
leave of absence from Williams & Connolly. Mr. Ferguson is elected to serve
as a Director pursuant to the Letter Agreement. Mr. Ferguson is also a
director of OsteoBiologics, Inc., Orthopaedic Tissue Technology, LLC and
Tissue Engineering, Inc.
George G. Griffin, CPA has been Chief Financial Officer of the Company
since August 1993. He was elected Executive Vice President as of January 1994.
From 1979 until he joined the Company, Mr. Griffin was employed by Smith &
Nephew Richards Inc., a medical device manufacturer, and since January 1989 had
served as the Vice President of Finance of its orthopaedic business.
Jack E. Parr, Ph.D. was Vice President of Research and Development from
September 1993 until February 1994, when he was elected to Executive Vice
President of Research and Development. Prior to joining the Company and since
1980, Dr. Parr was employed by Zimmer, Inc., a medical device manufacturer where
he served as Vice President of Research from January 1991 through October 1993
and as Director of Advanced Technology from June 1980 to December 1990.
Allen H. DeSatnick has been President of Questus Division since October
1994. Prior to joining the Company and since 1989, Mr. DeSatnick was President
and part owner of Questus Technologies, Inc.
Richard H. Mazza was Vice President of Manufacturing from April 1994
until March 1996 when he was elected to Executive Vice President of Operations.
Prior to joining the Company, Mr. Mazza was employed by United States Surgical
Corporation as Senior Director of Operations.
Herbert W. Korthoff has been a Director of the Company since May, 1993,
serving as Chairman since July 1, 1993. Mr. Korthoff served as the Chief
Executive Officer of the Company from July 1993 to November 1995. Prior to
joining the Company, Mr. Korthoff was the Executive Vice President of
Operations, a member of the Executive Management Committee and a Director of
United States Surgical Corporation.
William J. Kidd has been a Director of the Company since July 1993. Mr.
Kidd has been an officer and principal shareholder of Kidd, Kamm & Company, a
privately owned investment firm (formerly a partnership), from 1987 when he
co-founded the firm until present. As of January 1, 1997, Mr. Kidd became an
officer, controlling shareholder and founder of Kidd & Company, LLC and is a
director of a number of other companies.
Kurt L. Kamm has been a Director of the Company since July 1993. Mr.
Kamm has been an officer and principal shareholder of Kidd, Kamm & Company, a
privately owned investment firm (formerly a partnership), from 1987 when he
co-founded the firm until present. As of January 1, 1997, Mr. Kamm became an
officer, director and co-founder of Kamm Theodore and is a director of a number
of other companies.
202
Walter S. Hennig has been a Director of the Company since April 1994.
Mr. Hennig had been Vice President of Quality Functions at United States
Surgical Corporation since 1976 prior to his retirement in March 1992.
Eric R. Hamburg has been a Director of the Company since January 1996.
Mr. Hamburg was a partner with Kidd, Kamm & Company until late 1996.
Presently he is a principal shareholder of Industrial Renaissance. Prior to
joining Kidd, Kamm & Company, Mr. Hamburg was a Senior Manager with Andersen
Consulting from 1985 to 1993, where he led the design and implementation of
numerous business turnarounds and profit improvement initiatives across a
wide variety of industries. Mr. Hamburg is a director of a number of other
companies.
203
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information with respect to
compensation paid by the Company during the period from January 1, 1994 through
December 31, 1996, to the Company's Chief Executive Officer and to the four most
highly compensated executive officers whose compensation exceeded $100,000 in
1996 (the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
Long Term Compensation
-------------------------------
Annual Compensation Awards
-------------------------------------------------------------------------------------------------------
(a) (b) (c) (d) (e) (g) (i)
Name and Other Annual Securities Underlying All Other
Principal Position Year Salary Bonus (1) Compensation Options (2) Compensation
- -----------------------------------------------------------------------------------------------------------------------------------
Richard D. Nikolaev 1994 $0 $0 $0 c. 20,000common $0
President and 1995 $51,754 (3) $0 $0 a. 110,000common $1,891 (4)
Chief Executive Officer 1996 $525,500 $0 $44,091 (5) $9,270 (6)
Lewis H. Ferguson, III 1994 $500,000 $0 $9,796 (7)(8) 0 $42,589 (9)
Senior Vice President 1995 $525,773 $0 $23,388 (10) 0 $7,936 (9)
1996 $525,498 $0 $65,681 (11) 0 $9,038 (12)
George G. Griffin, III, 1994 $165,000 $82,500 $3,064 (7)(8) 0 $16,123 (13)
Executive Vice President, 1995 $171,783 $0 $0 0 $8,489 (13)
Chief Financial Officer 1996 $176,200 $44,050 $0 (8) 0 $8,921 (14)
Jack E. Parr, Ph.D. 1994 $165,000 $82,500 - (8) b. 15,000common $63,293 (15)
Executive Vice President, 1,500preferred
Research and Development 1995 $171,783 $0 $0 $8,458 (15)
1996 $176,200 $44,050 $0 (8) 0 $10,122 (16)
Richard H. Mazza, 1994 $102,039 $45,917 $0 a. 25,000common $91,009 (17)
Executive Vice President, 1995 $150,700 $0 $0 a. 10,000common $21,057 (17)
Operations 1996 $173,317 $43,329 $0 (8) a. 30,000common $8,322 (17)
204
(1) Bonus payments for 1994 were calculated on 1994 performance, but paid
in the first quarter of 1995. Bonus payments for 1996 were calculated
on 1996 performance, but paid in the first quarter of 1997.
(2) Indicates the number of shares that may be purchased pursuant to
options granted. Options were granted under three separate plans and
are identified as "a" for options to purchase Class A Common Stock
granted pursuant to the 1993 Stock Option Plan; "b" for options to
purchase Class A Common Stock and Series A Preferred Stock granted
pursuant to the 1993 Special Stock Option Plan; "c" for options to
purchase Class A Common Stock granted pursuant to the 1994 Non-Employee
Stock Option Plan.
(3) Mr. Nikolaev joined the Company on November 28, 1995 as Chief Executive
Officer and President. His annualized salary in 1995 was $525,000.
(4) Represents $338 premium for group term life insurance and $1,553 of
401(k)employer matching contributions.
(5) Represents a housing stipend in the amount of $10,186, personal travel
expenses of $14,384, personal use of Company vehicle of $6,536, and
$12,985 to cover expected tax payments on all other annual
compensation.
(6) Represents $664 of club dues, $4,106 of group term life insurance, and
$4,500 of 401(k) employer matching contributions.
(7) Represents funds to cover expected tax payments on all other annual
compensation.
(8) Other perquisites and personal benefits were less than the lesser of
$50,000 or 10% of the total of annual salary and bonus.
(9) Includes $36,893 for relocation expenses, $2,376 for group term life
insurance and $3,320 of 401(k) employer matching contributions for
1994, and includes $844 for club dues, $2,592 for group term life
insurance and $4,500 of 401(k) employer matching contributions for
1995.
(10) Mr. Ferguson received a housing stipend of $23,388 in 1995.
(11) Includes a housing stipend of $18,000, personal travel expenses of
$16,202, personal use of Company vehicle of $12,000, and $19,479 to
cover expected tax payments on all other annual compensation.
(12) Includes $1,238 for club dues, $672 for vehicle expenses, $2,628 for
group term life insurance, and $4,500 for 401(k) employer matching
contributions.
(13) Includes $15,690 for relocation expenses and $433 for group term life
insurance in 1994. For 1995, includes $3,565 for club dues, $424 for
group term life insurance and $4,500 of 401(k) employer matching
contributions.
(14) Represents $3,982 of club dues, $439 of group term life insurance, and
$4,500 of 401(k) employer matching contributions.
(15) Includes $60,860 for relocation expenses, $1,121 for group term life
insurance and $1,312 of 401(k) employer matching contributions in 1994.
For 1995, includes $2,556 for club dues, $1,096 for group term life
insurance, $306 for travel and $4,500 of 401(k) employer matching
contributions.
205
(16) Represents $4,486 of club dues, $1,136 of group term life insurance,
and $4,500 of 401(k) employer matching contributions.
(17) Represents relocation expenses of $89,666 and $1,097 of 401(k) employer
matching contributions in 1994 and $16,207 of relocation and $4,500 of
401(k) employer matching contributions in 1995. Also represents group
term life insurance of $246 in 1994 and $350 in 1995. For 1996,
represents $3,112 of club dues, $710 for group term life, and $4,500 of
401(k) employer matching contributions.
206
The following table sets forth certain information with respect to
stock options granted to the Named Executive Officers during 1996.
Option Grants in Last Fiscal Year
Potential Realizable Value
at Assumed Annual rates of
Stock Price Appreciation for
Option Term
Individual Grants
(a) (b) (c) (d) (e) (f) (g)
Number of % of Total
Securities Options Exercise
Underlying Granted to or Base
Options Employees in Price Expiration
Name Granted (#) Fiscal Year ($/Sh) Date 5% 10%
---- ----------- ----------- ------ ---- -- ---
Richard D. Nikolaev -0- N/A N/A N/A N/A N/A
Lewis H. Ferguson, III -0- N/A N/A N/A N/A N/A
George G. Griffin, III -0- N/A N/A N/A N/A N/A
Jack E. Parr, Ph.D. -0- N/A N/A N/A N/A N/A
Richard H. Mazza 30,000 25.34% 21.00 10/1/06 (1) 347,337 (2) 855,507 (2)
<FN>
(1) Options were granted under the Company's 1993 Stock Option Plan. Options under that Plan entitle holders to purchase shares
of Class A Common Stock and are conditional on employment. These options vest over a four-year period (in successive
yearly increments of 20%, 20%, 25% and 35% of the total grant) on the anniversary date of October 1, 1996, but can be
accelerated at the Board's discretion.
(2) Based upon the Company's internal risk adjusted valuation model, the options were granted to Mr. Mazza at the then current
market value of $21.00.
</FN>
207
The following table sets forth certain information with respect to stock
options held at December 31, 1996 by the Named Executive Officers.
Aggregated Option Exercises in Last Fiscal Year and FY-End Option Values
(a) (b) (c) (d) (e)
Value of Unexercised
In-the-Money(1)
Number of Securities Options at
Shares Underlying Unexercised FY-end ($)
Acquired Value Options at FY-end (#) Exercisable/
Name on Exercise Realized Exercisable/ Unexercisable(2) Unexercisable(3)
---- ----------- -------- ----------------------------- --------------------
Richard D. Nikolaev -0- -0- a. 22,000 / 88,000 common -0- / -0-
-0- -0- c. 15,000 / 5,000 common 108,450 /36,150
Lewis H. Ferguson, III -0- -0- a. -0- / 96,500 common -0- / 2,012,797
George G. Griffin, III -0- -0- a. 12,500 / 17,500 common 260,725 / 365,015
b. 1,500 / -0- preferred -0- / -0-
Jack E. Parr, Ph.D. 12,500 260,725 a. -0- / 17,500 common -0- / 365,015
b. 1,500 / -0- preferred -0- / -0-
Richard H. Mazza -0- -0- a. 16,250 / 8,750 common 338,943 / 182,508
-0- -0- d. 8,000 / 32,000 common -0- / -0-
(1) Given the lack of a public trading market for the Company's equity
securities at December 31, 1996, the fair market value of the unexercised
options is necessarily subjective, subject to change and for the purposes
of this table has been established by the Board of Directors of the
Company at $21.00 per share of Class A Common Stock. Shares of preferred
stock were valued at their cost and, accordingly, were not in-the-money
at December 31, 1996.
(2) Options under Plan "a" are conditional on employment and vest over a
four-year period (in successive yearly increments of 20%, 20%, 25% and
35% of the total grant) for these officers on the first through fourth
anniversary of June 30, 1993 but can be accelerated at the Board's
discretion. Options under Plan "b" are sold in units of 10 shares of
Class A Common Stock and 1 share of Series A Preferred Stock and are
conditioned only on employment as of March 31, 1995. Options under Plan
"c" were issued under the Company's 1994 Non-Employee Stock Option Plan
and vest equally over four years from the date of grant. Options held by
Mr. Ferguson under Plan "a" are subject to vesting criteria set forth in
the Letter Agreement. Options under Plan "d" are conditional on
employment and vest over a four-year period (in successive yearly
increments of 20%, 20%, 25% and 35% of the total grant) for these
officers on the first through fourth anniversary.
(3) Values do not consider any tax payments related to the exercise of the
options or sale of the underlying securities.
208
Director Compensation
Directors of the Company are not compensated for their services as
directors with the exception of (a) Mr. Walter Hennig, who receives $1,000 per
day of service as a director and, in consideration of his role as a consultant
to the Company, has been granted options to 5,000 shares of common stock of the
Company and (b) Mr. Herbert Korthoff, who pursuant to the Letter Agreement
receives an annual salary of $100,000 for his service as the Chairman of the
Company's Board of Directors. Mr. Hennig's options vest over a four year period
at the rate of 20%, 20%, 25% and 35% on the first through fourth anniversary of
January 1, 1994. All non-employee directors of the Company are reimbursed for
ordinary and necessary expenses incurred in attending board or committee
meetings.
Employment Contracts
Mr. Nikolaev's 1997 salary and Mr. Ferguson's 1997 salary remain
unchanged from prior year. Pursuant to the Letter Agreement, Mr.
Korthoff is paid an annual salary of $100,000, and is eligible to
receive a bonus as the Board of Directors may determine.
The Letter Agreement provides that the Company's Board of Directors
will consist of seven directors or as otherwise provided under the Company's
Restated Certificate of Incorporation. KKEP has the right to nominate three
directors, Mr. Korthoff has the right to nominate three directors (one of whom
is subject to KKEP's approval) and the holders of the Notes have the right to
nominate one director to the Company's Board.
Board Compensation Committee Interlocks and Insider Participation
The directors functionally acting as the Company's compensation
committee are Mr. Korthoff and Mr. Kidd. Mr. Nikolaev and Mr. Kidd
comprise the Option Committee. Mr. Kidd and Mr. Ferguson functionally
act as the Company's Audit Committee. There are no other committees of
the Board of Directors.
209
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following tables set forth, as of December 31, 1996, information
with respect to the beneficial ownership of shares of the Company's Class A
Common Stock and Series A Preferred Stock by (i) each stockholder known by the
Company to be the beneficial owner of more than 5% of either class of such
shares, (ii) each director of the Company, the Company's Chief Executive Officer
and each of the other Named Executive Officers (as defined in Item 11, Executive
Compensation), and (iii) all directors and executive officers of the Company as
a group. Unless otherwise indicated, the persons named in this table have sole
voting power and investment power with respect to all shares beneficially owned
by them.
Amount and Nature of Percentage
Title of Class Name and Address of Beneficial Owners Beneficial Ownership of Class
-------------- ------------------------------------- -------------------- ----------
Class A Common Stock Kidd Kamm Equity Partners, L.P. 5,353,820 44.3%
Three Pickwick Plaza
Greenwich, Connecticut 06830
Herbert W. Korthoff 1,797,150 (1) 14.88%
444 August Drive
Riverton, Wyoming 82501
Barbara Korthoff 1,797,150 (2) 14.88%
Riverton, Wyoming 82501
California Public Employee Retirement System 1,143,737 (3) 9.47%
1200 Prospect Street
La Jolla, California 92037
Princes Gate Investors, L.P. 741,110 (3) 6.14%
1585 Broadway
New York, New York 10036
William J. Kidd 5,353,820 (4) 44.3%
c/o Kidd, Kamm & Company
Three Pickwick Plaza
Greenwich, Connecticut 06830
Kurt L. Kamm 5,353,820 (4) 44.3%
c/o Kidd, Kamm & Company
9454 Wilshire Boulevard, Suite 920
Beverly Hills, California 90212
Richard D. Nikolaev 37,000 (5) (7)
Lewis H. Ferguson, III 479,920 (6) 4.0%
George G. Griffin 47,500 (7)
Jack E. Parr, Ph.D. 47,500 (7)
Richard H. Mazza 24,250 (7)
Walter S. Hennig 3,250 (7)
Eric R. Hamburg -0- -0-
All directors and officers as a group (10 7,890,678 65.32%
persons)
210
(1) Includes 96,500 shares of Class A Common Stock held by Mr. Korthoff's
wife, Barbara Korthoff, of which Mr. Korthoff disclaims beneficial
ownership.
(2) Includes 1,700,650 shares of Class A Common Stock held by
Mrs. Korthoff's husband, Herbert Korthoff, of which Mrs. Korthoff
disclaims beneficial ownership.
(3) Shares subject to warrants currently exercisable.
(4) Deemed to be the beneficial owners of the Class A Common Stock
beneficially owned by KKEP, since Mr. Kidd and Mr. Kamm control KKEP.
(5) Represents shares subject to options that are exercisable currently.
(6) Includes 96,500 shares subject to repurchase by KKEP under certain
conditions pursuant to the Letter Agreement, and includes 96,500 shares
of Class A Common Stock issuable pursuant to options granted to Mr.
Ferguson, which options may be exercisable within the next 60 days as
determined by formula contained in the Letter Agreement.
(7) Less than one percent (1%).
211
Amount and Nature of Percentage
Title of Class Name and Address of 5% Beneficial Owner Beneficial Ownership of Class
-------------- --------------------------------------- -------------------- --------
Series A Preferred Stock Kidd Kamm Equity Partners, L.P. 535,382 63.6%
Three Pickwick Plaza
Greenwich, Connecticut 06830
Herbert W. Korthoff 179,715 (1) 21.3%
444 August Drive
Riverton, Wyoming 82501
Barbara W. Korthoff 179,715 (2) 21.3%
444 Augusta Drive
Riverton, Wyoming 82501
William J. Kidd 535,382 (3) 63.6%
c/o Kidd, Kamm & Company
Three Pickwick Plaza
Greenwich, Connecticut 06830
Kurt L. Kamm 535,382 (3) 63.6%
c/o Kidd, Kamm & Company
9454 Wilshire Boulevard; Suite 920
Beverly Hills, California 90212
Richard D. Nikolaev -0- -0-
Lewis H. Ferguson, III 38,342 (4) 4.6%
George G. Griffin 1,500 (5) (6)
Jack E. Parr, Ph.D. 1,500 (5) (6)
Richard H. Mazza -0- -0-
Walter S. Hennig -0- -0-
Eric R. Hamburg -0- -0-
All directors and officers as a group (10
persons) 756,439 89.8%
<FN>
(1) Includes 9,650 share of Series A Preferred Stock held by Mr. Korthoff's wife Barbara Korthoff, of which Mr. Korthoff
disclaims beneficial ownership.
(2) Includes 170,065 shares of Series A Preferred Stock held by Mrs. Korthoff's husband, Herbert Korthoff, of which
Mrs. Korthoff disclaims beneficial ownership.
(3) Deemed to be the beneficial owners of the Series A Preferred Stock beneficially owned by KKEP, since Mr. Kidd and Mr. Kamm
control KKEP.
(4) Includes 9,650 shares subject to repurchase by KKEP under certain conditions pursuant to the Letter Agreement.
(5) Represents shares subject to options which are currently exercisable.
(6) Less than one percent (1%).
</FN>
212
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Management Agreement with Kidd Kamm & Company and its Affiliates
Kidd Kamm & Company, an affiliate of KKEP, has a management services
agreement with the Company pursuant to which it renders management, consulting
and related services to the Company for an annual management fee of $360,000,
subject to increases as determined by the Board of Directors of the Company,
plus out-of-pocket expenses.
Tissue Engineering, Inc.
In February, 1997, William J. Kidd and the other principals of Kidd and
Company, LLC purchased common stock and warrants to acquire additional common
stock options in Tissue Engineering Inc. (a company with which the Company
entered into a joint venture agreement in 1996), Kidd and Company, LLC is
providing financial advisory services to Tissue Engineering, Inc.
Transactions with Investors
Stock Transactions. At the Acquisition closing date, Herbert W.
Korthoff, the Company's Chairman, purchased 1,254,500 shares of Class A Common
Stock and 125,450 shares of Series A Preferred Stock plus 96,500 shares of Class
A Common Stock and 9,650 shares of Series A Preferred Stock purchased in his
wife's name, by delivering to the Company two recourse promissory notes in his
name, the H. Korthoff Group 1 Note in the principal amount of $1,232,877 with
respect to the purchase of the H. Korthoff Group 1 Shares, consisting of 579,000
shares of Class A Common Stock and 57,900 shares of Series A Preferred Stock,
and the H. Korthoff Group 2 Note in the principal amount of $1,438,356 with
respect to the purchase of the H. Korthoff Group 2 Shares, consisting of 675,500
shares of Class A Common Stock and 67,550 shares of Series A Preferred Stock and
by delivering to the Company two promissory notes in his wife's name, the Mrs.
Korthoff Group 1 Note in the principal amount of $102,739 with respect to the
purchase of the Mrs. Korthoff Group 1 Shares, consisting of 48,250 shares of
Class A Common Stock and 4,825 shares of Series A Preferred Stock, and the Mrs.
Korthoff Group 2 Note in the principal amount of $102,739 with respect to the
purchase of the Mrs. Korthoff Group 2 Shares, consisting of 48,250 shares of
Class A Common Stock and 4,825 shares of Series A Preferred Stock.
On June 1, 1994, the Company requested that the holders of the Notes
waive certain provisions of the Indenture to allow the Company to repurchase
from Mr. Korthoff 798,380 shares of Class A Common Stock and 79,838 shares of
Series A Preferred Stock for use in employee incentive programs. The Company was
notified on July 22, 1994 of the approval of the holders of the Notes for such a
transaction and accordingly repurchased such shares for $1,700,549 through a pro
rata credit of that sum against the principal balance of the H. Korthoff Group 1
Note and the H. Korthoff Group 2 Note. On December 27, 1995, Herbert W. Korthoff
and Barbara Korthoff paid the Company $1,176,162 representing the entire
principal of the Korthoff Group 1 Note and Korthoff Group 2 Notes. The
213
balance of the Group 1 Notes and Group 2 Notes, representing the accrued but
unpaid interest on such notes, is evidenced by the Amended Note.
Lewis H. Ferguson III, a director and officer of the Company, purchased
at the Acquisition closing date 289,500 shares of Class A Common Stock and
28,950 shares of Series A Preferred Stock by delivering to the Company two
recourse promissory notes, the Ferguson Group 1 Note in the principal amount of
$410,959 with respect to the purchase of the Ferguson Group 1 Shares consisting
of 193,000 shares of Class A Common Stock and 19,300 shares of Series A
Preferred Stock and the Ferguson Group 2 Note (together with the Ferguson Group
1 Note, the "Ferguson Notes") in the principal amount of $205,480 with respect
to the purchase of the Ferguson Group 2 Shares consisting of 96,500 shares of
Class A Common Stock and 9,650 shares of Series A Preferred Stock.
The Amended Note is full recourse and (i) will mature on June 30, 1998,
subject to acceleration upon a sale of all or substantially all of the business,
assets or issued and outstanding capital stock of the Company or the successful
completion of an initial public offering by the Company of any of its equity
securities pursuant to the Securities Act, and (ii) is secured by a pledge of,
and the Company is entitled to offset, all dividends payable on the Series A
Preferred Stock held by Herbert W. Korthoff and Barbara Korthoff. The Ferguson
Notes are full recourse and (i) bear interest, payable semi-annually (but which
interest may be, and to date has been, deferred and added to principal at the
option of the maker), at the rate of 10% per annum, (ii) will mature on June 30,
1998, subject to acceleration upon a sale of all or substantially all of the
business, assets or issued and outstanding capital stock of the Company or the
successful completion of an initial public offering by the Company of any of its
equity securities pursuant to a registration statement under the Securities Act,
and (iii) are secured by the pledge of the Ferguson Group 1 and Ferguson Group 2
Shares to the Company.
Pursuant to the Letter Agreement among KKEP, the Company and each of
Mr. Korthoff, his wife and Mr. Ferguson, each dated June 30, 1993, upon the
occurrence of an Event of Default (defined as including (a) any default in the
payment of principal or interest which has continued for ten (10) business days,
or (b) certain bankruptcy, insolvency or similar proceedings not dismissed,
vacated or stayed within sixty (60) days) under the Ferguson Notes, the Company
has the right to foreclose upon the Ferguson Shares, and KKEP has the right to
elect to succeed to all the rights of the Company under said Ferguson Notes and
related stock pledge agreements. In the event KKEP elects to succeed to all
rights of the Company under said Ferguson Notes, KKEP must make full payment to
the Company of the outstanding balance of the Ferguson Notes, as the case may
be, and allow each of the other initial cash equity investors in the Company
(except the defaulting noteholder) to participate in such purchase in proportion
to their respective ownership of the capital stock of the Company.
Mr. Ferguson also owns 9,650 shares of Series A Preferred Stock and
96,500 shares of Class A Common Stock of the Company which are subject to
repurchase by KKEP or the Company in the event that KKEP has not achieved a
certain target rate of return on its equity investment in
214
the Company in accordance with a formula that is set forth in an attachment to
the Letter Agreement. In addition, Mr. Ferguson holds options to purchase 96,500
shares of the Company's Class A Common Stock that vest only in the event that
KKEP achieves the target rates of return described in the attachment to the
Letter Agreement.
Payments to Outside Counsel. Mr. Ferguson is a partner (on an
extended leave of absence) in the law firm of Williams & Connolly, which
the Company retained during fiscal years 1994, 1995 and 1996 and
proposes to retain during fiscal year 1997.
Officer and Director Arrangements. Mr. Korthoff's, Mr. Ferguson's
and Mr. Nikolaev's salaries will remain unchanged for 1997.
The Letter Agreement provides that the Company's Board of Directors
will consist of seven directors or as otherwise provided under the Company's
Restated Certificate of Incorporation. KKEP has the right to nominate three
directors, Mr. Korthoff has the right to nominate three directors (one of which
is subject to KKEP's approval) and the holders of the Notes have the right to
nominate one director to the Company's Board. Messrs. Kidd, Kamm and Hamburg are
of KKEP's nominees and Messrs. Korthoff, Ferguson, and Hennig are Mr. Korthoff's
nominees. Neither KKEP nor the noteholders has nominated any other directors as
of the date hereof.
Principal Stockholders' Agreement. Pursuant to the terms of the
Principal Stockholders' Agreement, except for certain permitted transfers
including the repurchase by KKEP and such of the other parties to the agreement
of a defaulting person's shares subject to pledge to the Company, no person
subject thereto may sell any of his, her or its shares of capital stock of the
Company.
The Principal Stockholders' Agreement also provides that if, at any
time prior to the third anniversary of the Principal Stockholders' Agreement and
provided no Event of Default (as defined in the Indenture) has occurred and is
continuing under the terms of the Indenture, the holders of more than 662/3% of
the issued and outstanding shares (the "Requisite Percentage") determine to sell
all of their shares in an arm's-length transaction to an unaffiliated third
person, then all holders will sell all of their shares under the terms of the
sale, subject to certain conditions, but not to any restrictions as to price. At
any time after the third anniversary of the Principal Stockholders' Agreement,
or at any time an Event of Default under the terms of the Indenture has occurred
and is continuing at the time a contract of sale is entered into, the Requisite
Percentage necessary to cause the other stockholders to sell their shares in a
qualified transaction will be a majority-in-interest of the issued and
outstanding shares of capital stock.
The Principal Stockholders' Agreement also grants holders tag- along
rights making any transfers subject to the right of other holders to participate
in such transfer in proportion to their ownership of shares of the Company's
capital stock at the same price per share being offered to the transferring
holder. The Principal Stockholders' Agreement terminates on the closing of an
underwritten public offering
215
of the Company's shares of Common and Preferred Stock pursuant to a registration
statement under the Securities Act declared effective by the Securities and
Exchange Commission.
Other Related Party Transactions. In 1995, Mr. Nikolaev was paid
a consulting fee of $135,000 for consulting services performed for the
Company. At the election of Mr. Nikolaev, such amount was paid to the
company through which the services were rendered and which is owned by
one of the members of his family.
On June 30, 1994 Mr. Ferguson received a loan from the Company in the
amount of $75,000 for the purchase of a residence. That loan bears interest at
7.25%, the prime rate as of June 30, 1994. The original note was due January 1,
1996, and has been extended until June 30, 1997, and is secured by Mr.
Ferguson's stock in the Company.
216
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
8-K.
(a) The following documents are filed or incorporated by
reference as part of this Form 10-K:
1. Financial Statements and Financial Statement
Schedules:
The "Index to Financial Statements" set forth on page
53 of this Form 10-K is incorporated herein by
reference.
Schedules have been omitted because either they are
not required or the information is included elsewhere
in the financial statements and notes thereto.
2. Exhibits (Exhibits listed below without asterisks are
filed herewith.)
EXHIBIT DESCRIPTION OF EXHIBIT
2.1* Purchase and Sale Agreement, dated May
14, 1993, among the Company, Dow Corning
and Dow Corning Wright Corporation.
3.1****** Restated Certificate of Incorporation of
the Company dated September 25, 1995.
3.2* By-Laws of the Company.
4.1* Indenture dated as of June 30, 1993,
between the Company and the First
National Bank of Boston, as trustee.
4.1(a)* First Supplemental Indenture, dated as
of November 1, 1993, between the Company
and The First National Bank of Boston.
4.2* Security Agreement dated as of June 30,
1993, between the Company and BancBoston
Trust Company of New York, as collateral
agent acting on behalf of the First
National Bank of Boston.
4.3* Pledge Agreement, dated as of June 30,
1993, between the Company and BancBoston
Trust Company of New York, as collateral
agent acting on behalf of The First
National Bank of Boston.
4.4* Form of Purchase Agreement, dated June
30, 1993, between the Company and the
purchasers of the Notes.
217
4.5* Registration Rights Agreement, dated as
of June 30, 1993, between the Company
and the purchasers of the Notes.
4.6***** Series B Preferred Stock Purchase and
Class A Common Stock Warrant Agreement,
dated July 29, 1994, between the Company
and CalPERS.
4.6(a)******* Amendment No. 1 dated September 25, 1995
to Series B Preferred Stock Purchase and
Class A Common Stock Warrant Agreement,
dated July 29, 1994 between the Company
and CalPERS.
10.1* Product Manufacturing Agreement, dated
June 30, 1993, between the Company and
Dow Corning Corporation.
10.2* Revolving Credit Agreement, dated
September 30, 1993, between the Company
and Heller Financial, Inc.
10.3* Principal Stockholders' Agreement, dated
June 30, 1993, among the Company and
certain of its stockholders.
10.4* Omnibus Stockholders' Agreement, among
the Company and certain of its
stockholders.
10.5* License Agreement, dated June 25, 1993,
between the Company and Dr. Alfred B.
Swanson.
10.6**** 1993 Stock Option Plan
10.7**** 1993 Special Stock Option Plan
10.8**** Employee Common Stock Grant Plan
10.9**** Distributor Stock Purchase Plan
10.10* Industrial Development Lease Agreement
date as of July 9, 1985 between The Industrial
Development Board of The City of Arlington, Tennessee
(the "Arlington IDB") and Dow Corning Wright, Inc.
10.11* Lease and Security Agreement dated as of
April 1, 1974 between the Arlington IDB
and Wright Manufacturing Company
together with First Supplement to Lease
dated as of December 1, 1981.
218
10.12* Industrial Development Lease Agreement
dated as of June 29, 1984 between
Langston Associates and the Arlington
IDB.
10.13* Letter Agreements dated June 30, 1993
among the Company and certain of its
Stockholders with Promissory Notes and
Stock Pledge and Security Agreements
attached.
10.14*** Letter Agreement dated June 30, 1993
between KKEP and Herbert W. Korthoff,
Lewis Ferguson, and Barbara Korthoff.
10.14(a)***** Amendment dated July 29, 1994 to Letter
Agreement dated June 30, 1993 between
KKEP and Herbert W. Korthoff, Lewis
Ferguson, and Barbara Korthoff.
10.15* Agreement dated January 24, 1983,
between Leo A. Whiteside, M.D. and the
Company.
10.16** Acquisition Agreement dated February 5,
1994, between the Company and
OrthoTechnique.
10.17***** Distribution Agreement dated December
20, 1993, between the Company and Kaneka
Medix Corporation.
10.18***** Research and Development Agreement dated
October 7, 1994, between the Company and
OsteoBiologics, Inc.
10.19*** Acquisition Agreement dated December 8,
1994, between the Company and Orthomet.
10.20***** 1994 Distributor Stock Option Plan.
10.21***** Non-qualified Stock Option Agreement for
Non-Employees.
10.22******* Securityholders Agreement, dated
September 25, 1995, between the Company,
the purchasers named therein and PG
Investors, Inc., as agent.
10.23******* Distribution Agreement dated February
22, 1996, between the Company and
Century Medical, Inc.
10.24******** Revolving Credit Agreement, dated
September 13, 1996 between the Company
and Sanwa Business Credit Corporation.
219
10.25 Joint Venture Agreement, dated July 12,
1996 between the Company and Tissue
Engineering, Inc.
11.1 Statement re: Computation of earnings
per share.
12.1 Statement re: Computation of ratios of
earnings to fixed charges and preferred
dividends.
21.1 Subsidiaries of the Company.
23.2 Consent of Arthur Andersen LLP
* Document incorporated by reference from
Registration Statement on Form S-4 No.
33-69286 filed by the Company on
November 10, 1993.
** Document incorporated by reference to
Current Report on Form 8-K dated as of
February 5, 1994.
*** Document incorporated by reference to
Current Report on Form 8-K dates as of
December 8, 1994.
**** Document incorporated by reference to
Annual Report on Form 10-K filed March 25, 1994.
***** Document incorporated by reference to
Annual Report on Form 10-K filed March 31, 1995.
****** Document incorporated by reference to
Quarterly Report on Form 10-Q filed November 14, 1995.
******* Document incorporated by reference to
Annual Report on Form 10-K Filed March
31, 1996.
******** Document incorporated by reference to
current report on Form 8-K dated as of
September 13, 1996.
(b) Reports on Form 8-K
The registrant filed a current report on Form 8-K on
September 13, 1996 regarding the Revolving Credit
Agreement between the Company and Sanwa Business
Credit
Corporation.
220
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.
WRIGHT MEDICAL TECHNOLOGY, INC.
(Registrant)
BY: /s/Richard D. Nikolaev
Richard D. Nikolaev
President and Chief Executive Officer
DATE: March 25, 1997
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 the capacities and on the dates indicated.
SIGNATURE TITLE (CAPACITY) DATE
President, Chief Executive
Officer, and Director
/s/Richard D. Nikolaev (Principal Executive
Richard D. Nikolaev Officer) March 25, 1997
Chief Financial Officer
and Executive Vice
/s/George G. Griffin,III President (Principal
George G. Griffin, III Financial Officer) February 25, 1997
/s/Lewis H. Ferguson,III Senior Vice President
Lewis H. Ferguson, III Secretary, and Direct March 18, 1997
/s/Herbert W. Korthoff Chairman of the Board of
Herbert W. Korthoff Directors March 18, 1997
/s/William J. Kidd
William J. Kidd Director February 25, 1997
/s/Kurt L. Kamm
Kurt L. Kamm Director March 18, 1997
/s/Walter S. Hennig
Walter S. Hennig Director March 18, 1997
/s/Gregory K. Butler Vice President, Controller
Gregory K. Butler and Assistant Secretary March 18, 1997
/s/Eric R. Hamburg
Eric R. Hamburg Director March 18, 1997
221
INDEX TO FINANCIAL STATEMENTS
Wright Medical Technology, Inc.
Report of Independent Public Accountants...............................54
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1996
and 1995 ........................................................55
Consolidated Statements of Operations for the Year Ended
December 31, 1996, 1995 and 1994.................................56
Consolidated Statements of Cash Flows for the Year Ended
December 31, 1996, 1995 and 1994.................................57
Consolidated Statements of Changes in Stockholders'
Investment for the Year Ended December 31, 1996, 1995
and 1994.........................................................58
Notes to Consolidated Financial Statements.........................59
222
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of Wright Medical Technology, Inc.:
We have audited the accompanying consolidated balance sheets of Wright
Medical Technology, Inc. (a Delaware corporation) and subsidiaries as of
December 31, 1996 and 1995, and the related consolidated statements of
operations, changes in stockholders' investment and cash flows for the
years ended December 31, 1996, 1995 and 1994. 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 generally accepted auditing
standards. 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 financial statements referred to above present
fairly, in all material respects, the financial position of Wright Medical
Technology, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
results of their operations and their cash flows for the years ended
December 31, 1996, 1995 and 1994, in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
Memphis, Tennessee,
March 14, 1997.
223
WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
1996 1995
------------------ -----------------
ASSETS (in thousands) (in thousands)
Current Assets:
Cash and cash equivalents $ 910 $ 1,126
Trade receivables, net 18,289 18,269
Inventories, net 59,107 54,815
Prepaid expenses 1,692 1,353
Deferred income taxes 978 -
Other 2,540 1,948
------------------ -----------------
Total Current Assets 83,516 77,511
------------------ -----------------
Property, Plant and Equipment, net 33,659 39,141
Deferred Income Taxes - 2,608
Investment in Joint Venture 3,597 -
Other Assets 45,554 55,111
------------------ -----------------
$ 166,326 $ 174,371
================== =================
LIABILITIES AND STOCKHOLDERS' INVESTMENT
Current Liabilities:
Current portion of long-term debt $ 138 $ 446
Short-term borrowing 8,390 3,900
Accounts payable 6,063 7,769
Accrued expenses and other current liabilities 18,453 17,550
Deferred income taxes - 2,608
------------------ -----------------
Total Current Liabilities 33,044 32,273
------------------ -----------------
Long-Term Debt 84,668 84,462
Preferred Stock Dividends 17,999 14,938
Other Liabilities 3,189 570
Deferred Income Taxes 978 -
------------------ -----------------
Total Liabilities 139,878 132,243
------------------ -----------------
Commitments and Contingencies (Notes 1, 3, 5 & 11)
Mandatorily Redeemable Series B Preferred Stock, $.01 par value, (aggregate
liquidation value of $75.3 million, including accrued and unpaid dividends
of $4.1 million, 800,000 shares authorized, 600,000 shares
issued and outstanding) 59,959 46,757
Redeemable Convertible Series C Preferred Stock, $.01 par value, (aggregate
liquidation value of $40.3 million, including accrued and unpaid dividends
of $5.3 million, 350,000 shares authorized, issued and outstanding) 24,995 20,548
Stockholders' Investment:
Series A preferred stock, $.01 par value, (aggregate liquidation value of
$25.0 million, including accrued and unpaid dividends of $8.6 million),
1,200,000 shares authorized,
915,325 shares issued 9 9
Undesignated preferred stock, $.01 par value,
650,000 shares authorized, no shares issued - -
Class A common stock, $.001 par value, 46,000,000 shares authorized,
10,023,421 and 9,791,040 shares issued 10 10
Class B common stock, $.01 par value, 1,000,000 shares authorized,
no shares issued - -
Additional capital 53,853 51,470
Accumulated deficit (111,855) (76,557)
Other 516 930
------------------ -----------------
(57,467) (24,138)
Less - Notes receivable from stockholders (1,037) (1,037)
Series A preferred treasury stock, 86,688 shares (1) (1)
Class A common treasury stock, 878,130 shares (1) (1)
------------------ -----------------
Total Stockholders' Investment (58,506) (25,177)
------------------ -----------------
$ 166,326 $ 174,371
================== =================
The accompanying notes are an integral part of these consolidated balance sheets.
224
WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except earnings per share)
Year Ended December 31,
------------------------------------------------------
1996 1995 1994
--------------- --------------- --------------
Net sales $ 121,868 $ 123,196 $ 95,763
Cost of goods sold 44,433 33,722 43,610
---------------- ---------------- ---------------
Gross profit 77,435 89,474 52,153
---------------- ---------------- ---------------
Operating expenses:
Selling 47,437 47,085 33,227
General and administrative 19,357 23,358 23,274
Research and development 13,196 12,728 15,083
Purchased in-process research and development - - 27,700
Equity in loss of joint venture 500 - -
---------------- ---------------- ---------------
80,490 83,171 99,284
---------------- ---------------- ---------------
Operating income (loss) (3,055) 6,303 (47,131)
Interest expense (12,079) (11,935) (10,140)
Interest income 132 613 931
Other income (expense), net 413 146 (921)
---------------- ---------------- ---------------
Loss before income taxes (14,589) (4,873) (57,261)
Income tax provision (benefit) - 1,619 (7,881)
---------------- ---------------- ---------------
Net loss $ (14,589) $ (6,492) $ (49,380)
================ ================ ===============
Loss applicable to common stock $ (35,298) $ (19,783) $ (53,166)
================ ================ ===============
Loss per share of common stock $ (3.90) $ (2.24) $ (6.10)
================ ================ ===============
Weighted average common shares outstanding 9,059 8,825 8,717
================ ================ ===============
The accompanying notes are an integral part of these statements.
225
WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
-----------------------------------------------------
1996 1995 1994
--------------- ---------------- ---------------
Cash Flows From Operating Activities:
Net loss $ (14,589) $ (6,492) $ (49,380)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation 7,007 7,272 7,246
Instrument amortization 4,265 4,337 -
Provision for instrument reserves 3,647 - -
Provision for excess/obsolete inventory (453) (2,369) 12,114
Provision for sales returns (247) 290 (497)
Deferred income tax provision (benefit) - 1,270 (8,455)
Deferred income 1,502 - -
Amortization of intangible assets 3,266 3,747 1,351
Amortization of deferred financing costs 1,361 1,036 829
Loss on disposal/abandonment of equipment 485 97 138
Equity in loss of joint venture 500 - -
Purchased in-process research and development - - 27,700
Other 614 (178) (126)
Changes in assets and liabilities, net of effect of
purchases of businesses
Trade receivables 442 (522) (769)
Inventories (3,335) (18,101) (2,606)
Other current assets (1,104) (77) (166)
Accounts payable (1,706) 2,741 (3,282)
Accrued expenses and other liabilities (1,380) (16,848) 11,095
Other assets (840) (1,869) (2,903)
--------------- ---------------- ---------------
Net cash used in operating activities (565) (25,666) (7,711)
--------------- ---------------- ---------------
Cash Flows From Investing Activities:
Capital expenditures (3,778) (12,525) (10,550)
Purchases of businesses, net of cash acquired - - (60,688)
Other (884) (1,139) (497)
--------------- ---------------- ---------------
Net cash used in investing activities (4,662) (13,664) (71,735)
--------------- ---------------- ---------------
Cash Flows From Financing Activities:
Net proceeds from short-term borrowings 4,490 3,900 -
Proceeds from issuance of stock and stock warrants 1,278 33,409 59,493
Payments of debt issuance costs (387) - -
Payments of debt (446) (641) (63)
Proceeds from stockholders on notes receivable - 1,225 855
Other 76 (509) 44
--------------- ---------------- ---------------
Net cash provided by financing activities 5,011 37,384 60,329
--------------- ---------------- ---------------
Net decrease in cash and cash equivalents (216) (1,946) (19,117)
Cash and cash equivalents, beginning of period 1,126 3,072 22,189
--------------- ---------------- ---------------
Cash and cash equivalents, end of period $ 910 $ 1,126 $ 3,072
=============== ================ ===============
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ 10,474 $ 11,885 $ 9,336
=============== ================ ===============
Cash paid for income taxes $ 33 $ 234 $ 786
=============== ================ ===============
The accompanying notes are an integral part of these statements.
226
WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' INVESTMENT
(in thousands)
Number of Shares Notes
Series A Class A Series A Class A Receivable
Preferred Common Preferred Common Additional Accumulated From Treasury
Stock Stock Stock Stock Capital Deficit Other Stockholders Stock Total
BALANCE, 12/31/93 920 9,290 $9 $9 $19,589 ($3,608) $- ($4,397) $- $11,602
Purchase of treasury stock - - - - (1,740) - - 1,573 (2) (169)
Issuance of common stock
warrants - - - - 12,681 - - - - 12,681
Acquisition of business - 170 - - 2,336 - - - - 2,336
Preferred stock dividend - - - - - (3,447) - - - (3,447)
Payments on stockholder
notes receivable - - - - - - - 855 - 855
Accretion of preferred
stock discount - - - - - (339) - - - (339)
Net loss - - - - - (49,380) - - - (49,380)
Other (4) (19) - - (80) - 439 - - 359
----------- ----------- ---------- --------- --------- ----------- --------- ---------- ----- ---------
BALANCE, 12/31/94 916 9,441 9 9 32,786 (56,774) 439 (1,969) (2) (25,502)
Issuance of common stock - 350 - 1 497 - - - - 498
Issuance of common stock
warrants - - - - 18,187 - - - - 18,187
Preferred stock dividend - - - - - (10,455) - - - (10,455)
Payments on stockholder
notes receivable - - - - - - - 1,225 - 1,225
Accretion of preferred
stock discount - - - - - (2,836) - - - (2,836)
Net loss - - - - - (6,492) - - - (6,492)
Other (1) - - - - - 491 (293) - 198
----------- ----------- ---------- --------- --------- ----------- --------- ---------- ----- ---------
BALANCE, 12/31/95 915 9,791 9 10 51,470 (76,557) 930 (1,037) (2) (25,177)
Issuance of common stock - 232 - - 2,383 - - - - 2,383
Preferred stock dividend - - - - - (14,251) - - - (14,251)
Accretion of preferred
stock discount - - - - - (6,458) - - - (6,458)
Net loss - - - - - (14,589) - - - (14,589)
Other - - - - - - (414) - - (414)
----------- ----------- ---------- --------- --------- ----------- --------- ---------- ------ ---------
BALANCE, 12/31/96 915 10,023 $9 $10 $53,853 ($111,855) $516 ($1,037) ($2) ($58,506)
=========== =========== ========== ========= ========= =========== ========= ========== ====== =========
The accompanying notes are an integral part of these statements.
227
WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Description of Business -
Wright Medical Technology, Inc. and its subsidiaries (the "Company")
engage in the business of developing, manufacturing and selling orthopaedic
products, principally knee and hip implants. The Company's products are designed
to restore mobility and relieve pain through the replacement of damaged or
diseased joints. The Company distributes its products through various
distributors with approximately 75% of its products sold in the United States.
The Company purchased substantially all of the assets of Dow Corning Wright
Corporation ("DCW") on June 30, 1993 (the "DCW Acquisition").
Liquidity and Capital Resources -
Since the DCW Acquisition, the Company's strategy has been to position
itself for aggressive growth through new product development and the acquisition
of new technologies through license agreements, joint venture arrangements and
the purchase of other companies in the orthopaedic industry (see Note 2). The
Company has funded this strategy through the sale of $85 million of senior debt
securities and the contribution of approximately $15 million of equity at the
time of the DCW Acquisition. Further, the Company has obtained additional
capital through the issuance of $60,000,000 of Series B Preferred Stock in 1994
and $35,000,000 of Series C Preferred Stock in 1995 (see Note 8). The Company
has also funded its growth and working capital requirements through the use of
revolving lines of credit (see Note 7).
The Company has incurred significant losses since its inception and
anticipates incurring a loss during 1997. Additionally, the Company's projected
working capital requirements for 1997 indicate a continued reliance on its
revolving credit facility. Accordingly, management continues to closely monitor
the Company's working capital needs and believes that the Company's current
revolving line of credit will be sufficient to meet its working capital
requirements throughout 1997.
In July 1998, the Company's first annual sinking fund payment of $28.3
million is due on its senior debt securities. Prior to that time, management
believes that it will need to effect a recapitalization plan for the Company. In
this regard, management has begun discussions with a limited number of
investment banks to assess the various alternatives available to the Company
including, without limitation, refinancing its senior debt securities and an
initial public offering of equity securities. Management believes that a
successful plan of recapitalization will be completed prior to July, 1998;
however, there can be no assurance that such a recapitalization plan can be
consummated.
228
Significant Risks and Uncertainties -
Inherent in the accompanying financial statements are certain risks and
uncertainties. These risks and uncertainties include, but are not limited to,
timely development and acceptances of new products, impact of competitive
products, regulatory approval of new products, regulation of current products,
disposition of certain litigation matters (see Note 11) and the Company's
ability to accurately forecast and manage its working capital requirements.
Significant Accounting Policies -
Principles of Consolidation
The accompanying consolidated financial statements include the accounts
of the Company and its wholly-owned domestic and foreign subsidiaries. All
significant intercompany accounts and transactions have been eliminated. The
Company accounts for its investment in the Orthopaedic Tissue Technology L.L.C.
joint venture under the equity method of accounting.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include all cash balances and short-term
investments with original maturities of three months or less.
Allowance for Returns
An allowance is maintained for anticipated future returns of products
sold by the Company. An allowance for returns of approximately $0.6 million and
$1.2 million is included as a reduction of trade receivables at December 31,
1996 and December 31, 1995, respectively.
Inventories
Inventories are stated at the lower of cost or market, with cost being
determined using the first-in, first-out ("FIFO") method. Inventory reserves are
established to reduce the carrying amount of obsolete and excess inventory to
its net realizable value. The Company principally follows an inventory reserve
formula that reserves inventory balances based on historical and forecasted
sales.
229
Statement of Position 94-6 ("SOP 94-6"), issued by the American
Institute of Certified Public Accountants, requires, among other things, certain
disclosures regarding the use of estimates in the preparation of financial
statements. SOP 94-6 was required to be adopted by the Company in 1995. In that
regard, management has made its best estimate in determining the required level
of the inventory reserves discussed above and does not expect any material
changes thereto; however, given the subjective nature of the reserves, the
Company's estimate of the required reserves could change in the future.
Property and Depreciation
Property, plant and equipment are carried at cost. Depreciation is
provided on a straight-line basis over estimated useful lives of 15 to 20 years
for land improvements, 15 to 45 years for buildings, 3 to 10 years for machinery
and equipment, and 5 to 15 years for furniture, fixtures and equipment.
Expenditures for major renewals and betterments that extend the useful life of
the assets are capitalized. Maintenance and repair costs are charged to expense
as incurred. Upon sale or retirement, the asset cost and related accumulated
depreciation are eliminated from the respective accounts, and any resulting gain
or loss is included in income.
Instruments loaned to and used by surgeons in the implantation of the
Company's products are included in property, plant and equipment and depreciated
on a straight-line basis over periods not to exceed five years with adjustments
made as necessary for identified impairments in carrying value.
Impairment of Long-Lived Assets
In March 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
("SFAS No. 121"), which requires impairment losses to be recorded on long-lived
assets used in operations when indicators of impairment are present. During
1996, the Company adopted SFAS No. 121 which did not have a material effect on
its consolidated financial position or operating results.
Goodwill and Other Intangible Assets
The cost of intangible assets is amortized over the estimated periods
benefited, but not exceeding 40 years. The realizability of goodwill and other
intangibles is evaluated periodically as events or circumstances indicate a
possible inability to recover their carrying amount. Such evaluation is based on
various analyses, including cash flow and profitability projections. These
analyses necessarily involve significant management judgement. At December 31,
1996, management believes that the carrying value of its goodwill and other
intangibles is realizable.
230
Stock-Based Compensation
In October 1995, the FASB issued Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No.
123"). This new standard encourages, but does not require, companies to
recognize compensation expense for grants of stock, stock options, and
other equity instruments based on a fair-value method of accounting.
Companies that do not choose to adopt the new expense recognition rules
of SFAS No. 123 will continue to apply the existing accounting rules
contained in Accounting Principles Board Opinion No. 25 ("APB No. 25")
and related Interpretations, but will be required to provide pro forma
disclosures of the compensation expenses determined under the fair-value
provisions of SFAS No. 123, if material. The Company adopted the
disclosure provisions only of SFAS No. 123 during 1996.
Income Taxes
Income taxes are accounted for pursuant to the provisions of Statement
of Financial Accounting Standards No. 109, "Accounting for Income Taxes." This
statement requires the use of the liability method of accounting for deferred
income taxes. The provision for income taxes includes federal, foreign, and
state income taxes currently payable and those deferred because of temporary
differences between the financial statement and tax bases of assets and
liabilities. Provisions for federal income taxes are not made on the
undistributed earnings of foreign subsidiaries where the subsidiaries do not
have the capability to remit earnings in the foreseeable future and when
earnings are considered permanently invested. Undistributed earnings of foreign
subsidiaries at December 31, 1996 are insignificant.
Research and Development Costs
Research and development costs are charged to expense as incurred or
when expenditures for such costs are contractually obligated and the amount is
determinable.
Foreign Currency Translation
Revenues and expenses for foreign activities are translated at average
exchange rates during the period. Assets (primarily inventories and receivables)
located outside the U.S. are translated into U.S. dollars using end-of-period
exchange rates. The cumulative foreign currency translation adjustment at
December 31, 1996 and 1995 is not significant.
Earnings Per Share
Net loss per common share is computed by dividing net loss, plus
preferred stock dividends and accretion, by the weighted average common shares
outstanding during the period. Because of the net loss applicable to common
stock, the assumed exercise of common stock equivalents has not been included in
the computation of weighted average shares outstanding because their effect
would be anti-dilutive.
231
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is practicable to
estimate that value:
- Cash and cash equivalents - The carrying amount approximates fair
value because of the short maturities of the cash equivalents.
- Long-term debt - At December 31, 1996 and 1995, the fair value of
the Series B Notes was approximately $85.9 million and $86.7
million, respectively, based upon market quotes provided by an
investment banker. The carrying amount of these notes was
approximately $84.4 million and $84.3 million at December 31, 1996
and 1995, respectively.
- Series B and C preferred stock - These are specialized instruments
with various terms and preferential treatment which render it
impracticable to determine their current fair value.
- Noncurrent distributor receivables - The fair value is based upon
the anticipated cash flows discounted at rates currently established
by management. The fair value of these receivable balances at
December 31, 1996 and 1995 approximates book value.
Reclassifications
Certain prior year amounts have been reclassified to conform to the 1996
presentation.
2. ACQUISITIONS OF BUSINESSES
Orthopaedic Tissue Technology, L.L.C.
On July 12, 1996 the Company and Tissue Engineering, Inc. entered into a
joint venture agreement to create a joint venture named Orthopaedic Tissue
Technology, L.L.C. ("OTT"). The Company executed a promissory note for
$1,500,000 of which $630,000 was drawn in 1996. The Company will also make
additional funding contributions of $1,500,000 to OTT on July 12, 1997 and 1998.
Tissue Engineering, Inc. contributed the license to certain proprietary
technology to OTT. The Company has a 49% equity interest in OTT and will receive
50% of OTT's annual profit/ losses. OTT will develop and distribute biological
products for musculoskeletal applications. Products are designed to reproduce
the events of tissue formation including the treatment of medical conditions
involving disease, injury or deterioration of ligaments, tendons, cartilage or
bone and sports related injuries. The Company accounts for its investment in OTT
under the equity method of accounting and has reflected the present value of its
future funding commitments as a liability in the accompanying consolidated
financial statements.
232
U.S. Gypsum
On September 30, 1996, the Company entered into an Asset Purchase
Agreement to purchase the biomaterials business of the Industrial Gypsum
Division of United States Gypsum Company ("USG"). The Company will pay $750,000
for this business in four quarterly installments beginning on December 31, 1996.
The purchase price was principally allocated to existing patents and will be
amortized over 5 years. The Company also receives the right to sell and
distribute the OSTEOSET(TM) medical grade calcium sulfate pellets for a 25 year
period. The Company will pay USG a royalty of 6% of sales, net of commissions,
on this product.
Orthomet
On December 8, 1994, the Company acquired Orthomet, Incorporated
("Orthomet"), a Minnesota corporation, for a cash price of approximately $64.6
million, including related fees and expenses. Orthomet designed, manufactured
and marketed selected orthopaedic reconstructive implants and related surgical
instrumentation. The acquisition was accounted for as a purchase and,
accordingly, the consolidated financial statements include the results of
operations of Orthomet from December 8, 1994.
The accompanying financial statements include the estimated fair value
of assets acquired and liabilities assumed by the Company. A summary of the
purchase transaction and the final allocation of the purchase price is as
follows (in thousands):
Purchase price:
Cash purchase price $ 62,906
Transaction fees and expenses 1,678
--------------
Total purchase price $ 64,584
==============
Allocated to assets and liabilities as follows:
Current assets, including cash of $8,816 $ 21,130
Property, plant and equipment 3,496
In-process research and development 20,700
Other identifiable intangible assets 5,992
Excess of cost over net assets acquired 29,302
Current liabilities (10,787)
Other noncurrent items, net (5,249)
--------------
$ 64,584
==============
The amount allocated to in-process research and development was expensed
immediately following the acquisition because, in the opinion of management, the
technological feasibility of the in-process technology had not yet been
established and the technology has no alternative future use. Excess of cost
over net assets acquired is being amortized over 20 years on a straight-line
basis.
233
Questus
On October 13, 1994, the Company acquired Questus Corporation
("Questus"), a Massachusetts corporation, following the spin-off by Questus of
certain of its lines of business. The portion of Questus acquired by the Company
is in the business of medical device and arthroscopic research and development.
In exchange for the Questus shares, the Company paid $2 million in cash
and issued 169,630 shares of Class A Common Stock. An additional 84,818 shares
of Class A Common Stock are held in escrow until certain research and
development milestones are achieved; in connection therewith, the Company has
committed to the former Questus shareholders to spend $5 million towards the
achievement of these milestones. Additionally, the Company will pay the former
Questus shareholders a royalty equal to 5% of net sales of certain products.
The acquisition was accounted for as a purchase and, accordingly, the
consolidated financial statements include the results of operations of Questus
from October 13, 1994. A summary of the purchase transaction and the allocation
of the purchase price is as follows (in thousands):
Purchase price:
Cash paid $ 2,000
Value of Company shares issued 2,336
Transaction fees and expenses 62
-----------
Total purchase price $ 4,398
===========
Allocated to assets and liabilities as follows:
In-process research and development $ 7,000
Deferred income taxes (2,660)
Other 58
-----------
$ 4,398
===========
The amount allocated to in-process research and development was expensed
immediately following the acquisition because, in the opinion of management, the
technological feasibility of the in-process technology had not yet been
established and the technology has no alternative future use.
OrthoTechnique
On February 5, 1994, the Company acquired 100% of the outstanding
capital stock of OrthoTechnique S.A. ("OrthoTechnique") which is headquartered
in France. The purchase price, including acquisition costs, was 28.9 million
French francs (approximately U.S. $4.9 million) plus additional consideration
contingent upon OrthoTechnique's future operating results. OrthoTechnique is in
the business of distributing medical implants throughout France, including
products manufactured by the Company.
234
The acquisition was accounted for as a purchase and, accordingly, the
consolidated financial statements include the results of operations of
OrthoTechnique from the acquisition date. The acquisition resulted in
approximately $3.1 million of excess of cost over fair value of net assets
acquired, which is being amortized on a straight-line basis over 40 years.
An allocation of the purchase price is as follows(in thousands):
Current assets, including cash of $888 $ 3,591
Excess of cost over net assets acquired 3,093
Current liabilities (2,084)
Other 288
----------
$ 4,888
==========
Pro Forma Financial Information
Unaudited pro forma financial information relating to the Orthomet and
OrthoTechnique acquisitions is as follows (in thousands, except per share
amounts):
1994
------------
Net sales $ 121,799
Net loss (25,620)
Net loss per share of common stock $ (3.93)
The pro forma results are not necessarily indicative of what would have
occurred had the acquisitions actually been consummated at the beginning of the
period presented, or of future results of the combined companies.
3. INVENTORIES
The components of inventories, net of reserves, are as follows (in
thousands):
December 31,
------------------------
1996 1995
--------- --------
Raw materials $ 2,214 $ 3,146
Work in process 10,186 10,971
Finished goods 36,388 35,650
Surgical instruments 10,319 5,048
--------- --------
$ 59,107 $ 54,815
========= ========
In April 1996, the Company instituted a new surgical instrument program
with its domestic distributor network. The program makes more
235
of the Company's surgical instruments available for sale to its distributors
and, thus, reduces the demand for loaner instruments. Concurrent with this
program adoption, the Company reclassified approximately $8.5 million of
surgical instruments from property, plant and equipment to inventory at their
net book value.
Generally, the Company's products are subject to regulation by the Food
and Drug Administration ("FDA"). Currently, management believes that the
Company's products comply with applicable FDA regulations and that the Company
has no significant inventory levels of products awaiting FDA approval that, if
such approvals were denied, would have a material effect on the
consolidated financial position or operating results of the Company.
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following (in thousands):
December 31,
------------------------
1996 1995
----------- ----------
Land and land improvements $ 844 $ 859
Buildings 5,696 5,619
Machinery and equipment 25,036 22,824
Furniture, fixtures and equipment 13,033 12,672
Loaner instruments 14,174 17,633
----------- ----------
58,783 59,607
Less: Accumulated depreciation (25,124) (20,466)
----------- ----------
$ 33,659 $39,141
=========== -=========
5. INTANGIBLE ASSETS
Other assets include certain intangible assets as follows (in
thousands):
December 31,
------------------------
1996 1995
----------- -----------
Excess of cost over net assets acquired $ 35,461 $ 35,629
Distribution network 4,800 4,800
Patents, licenses and trademarks 3,137 2,439
Other 3,004 2,962
----------- -----------
46,402 45,830
Less: Accumulated amortization (8,528) (5,656)
----------- -----------
$ 37,874 $ 40,174
=========== ===========
236
Excess of cost over net assets acquired is being amortized over periods
ranging from 10 to 40 years on a straight-line basis. Other intangibles are
being amortized over periods ranging from 2 to 25 years on either a
straight-line or double declining balance basis.
6. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
A detail of accrued expenses and other current liabilities is as follows
(in thousands):
December 31,
-------------------------
1996 1995
------------ -----------
Interest $ 4,668 $ 4,619
Employee benefits 3,489 2,350
Joint venture 2,105 -
Research and development - 2,600
Commissions 1,358 1,385
Taxes 761 1,194
Distributor product reserve 161 618
Professional fees 1,088 1,020
Other 4,823 3,764
----------- -----------
$ 18,453 $ 17,550
============ ===========
7. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
December 31,
------------------------
1996 1995
------------ -----------
10-3/4% Series B Senior Secured
Notes, net of unamortized
discount of $572 and $735 $ 84,428 $ 84,265
Capital lease obligations 378 643
---------- -----------
84,806 84,908
Less current portion (138) (446)
---------- ----------
$ 84,668 $ 84,462
========== ==========
On June 30, 1993, the Company issued 10-3/4% Series A Senior Secured
Notes (the "Series A Notes") with an aggregate principal amount of $85 million.
Attached to the Series A Notes were 350,000 common
237
stock purchase warrants which were sold for $.02 per warrant. The Series A Notes
were issued at 99.389% of par resulting in an effective interest rate of
approximately 10-7/8%.
The Series A Notes were issued pursuant to a Registration Rights
Agreement whereby the Company agreed to use its best efforts to effect a
registration statement for a new issue of senior secured notes of the Company
identical in all respects to the Series A Notes. On December 8, 1993, an
exchange offer was consummated whereby the Company issued $85 million of 10-3/4%
Series B Senior Secured Notes (the "Series B Notes") in exchange for the Series
A Notes. In connection with the issuance of the Series A Notes and Series B
Notes, the Company incurred costs aggregating approximately $3.9 million which
have been deferred and are being amortized over the 7-year term of the Series B
Notes.
The Series B Notes mature on July 1, 2000 and are subject to certain
optional and mandatory redemption provisions. On or after July 1, 1996, the
Company has the option to redeem the Series B Notes, in whole or in part, at the
following redemption price (expressed as a percentage of principal amount):
Date Percentage
---- ----------
July 1, 1996 - June 30, 1997 106%
July 1, 1997 - June 30, 1998 103%
July 1, 1998 and thereafter 100%
The mandatory redemption provision of the Series B Notes requires
sinking fund payments of approximately $28.3 million on July 1, 1998 and 1999.
If a change in control, as defined, of the Company occurs, the note holders have
the right to require the Company to repurchase, in whole or in part, the Series
B Notes at 101% of the aggregate principal amount of the Series B Notes.
Certain restrictions apply to the Series B Notes which limit, among
other things, (a) the issuance of additional debt or preferred stock, (b)
payment of cash dividends on, and redemption of, the Company's capital stock,
(c) consolidations, mergers, transfers or sales of all or substantially all of
the Company's assets and (d) transactions with affiliates. Additionally, the
Company is required to maintain specified levels of consolidated net worth, as
defined, throughout the term of the Series B Notes. At December 31, 1996, the
Company is in compliance with the Series B Notes covenants. Based upon current
operating projections, management believes the Company will meet its
consolidated net worth requirements as of December 31, 1997, its next scheduled
compliance date. However, to meet the consolidated net worth test at December
31, 1997, the Company will be required to pay dividends "in-kind" on the Series
B Preferred Stock (see Note 8) during 1997. Also, there can be no assurance that
the Company will achieve its operating plan for 1997.
The Series B Notes are secured by a first priority security interest in
certain of the fixed assets, intellectual property rights and other intangible
assets of the Company, now in existence or hereinafter acquired, other than
cash, cash equivalents, accounts
238
receivable and inventory, and by a first priority pledge of all the capital
stock of all current and future subsidiaries of the Company.
At December 31, 1996, the fair value of the Series B Notes was
approximately $85.9 million based upon a market quote provided by an investment
banker.
The Company had available to it a $30 million revolving line of credit
with Heller Financial, Inc. (the "Heller Agreement") that expired in September,
1996. The Company's projected cash flow requirements indicated that a similar
revolving credit agreement was needed to fund the on going working capital needs
of the Company. Management negotiated with several financial institutions and on
September 13, 1996, finalized and closed a Loan and Security Agreement with
Sanwa Business Credit Corporation (the "Sanwa Agreement") for a $25 million
(which can increase to $30 million upon the occurrence of certain events)
revolving line of credit which expires in September, 1999. As of December 31,
1996, this agreement provided an eligible borrowing base of $19.4 million and
the Company had drawn $8.4 million pursuant to this agreement. During 1996,
borrowings under the Heller and Sanwa Agreements averaged $12.5 million with a
maximum amount borrowed of $16.1 million, as compared to 1995 when borrowings
averaged $15.1 million and reached a high of $29.0 million. Borrowings under
this agreement are collateralized by the Company's accounts receivable and
inventories and bear interest at prime plus 1.5%. A guaranty fee of 3% per
annum is required on any letter of credit guaranties.
The agreement places various restrictions on the Company which limit,
among other things, (a) additional indebtedness, (b) acquisitions, (c)
consolidations, mergers, sales of all or substantially all of the Company's
assets and (d) transactions with affiliates. Additionally, the Company must meet
a specified cash flow coverage ratio.
8. CAPITAL STOCK
Common Stock
Two classes of common stock of the Company have been authorized for
issuance: Class A Common Stock and Class B Common Stock. The holders of Class A
Common Stock are entitled to one vote for each share of Class A Common Stock.
There are currently no shares of Class B Common Stock outstanding. Subject to
any preferential rights of any outstanding series of preferred stock designated
by the Board of Directors, the holders of Class A Common Stock are entitled to
receive, ratably, with the holders of any Class B Common Stock, such dividends,
if any, as may be declared from time to time by the Board of Directors.
Pursuant to a restated certificate of incorporation dated September 25,
1995 (the "Restated Certificate"), the Company has 47,000,000 authorized shares
of common stock consisting of 46,000,000 shares of Class A Common Stock and
1,000,000 shares of Class B Common Stock.
239
Preferred Stock
Pursuant to the Restated Certificate, the Company has 3,000,000
authorized shares of preferred stock consisting of 1,200,000 shares of Series A
Preferred Stock, 800,000 shares of Series B Preferred Stock, 350,000 shares of
Series C Preferred Stock, and 650,000 shares of undesignated preferred stock.
The Series C Preferred Stock is senior to the Series A Preferred Stock and
junior to the Company's Series B Preferred Stock with respect to dividends and
rights upon liquidation.
The Series A Preferred Stock is voting stock and, upon liquidation or
dissolution of the Company, entitles the holders to a preferential distribution,
subordinate to the Series B and Series C Preferred Stock, from the assets
legally available for distribution to stockholders after the payment of all
debts and liabilities of the Company. At December 31, 1996, the aggregate
preferential distribution would amount to $25.0 million, including accrued and
unpaid dividends ($8.6 million).
Dividends on the Series A Preferred Stock accumulate at the rate of 12%
per annum for a five-year period and at the rate of 15% per annum thereafter,
subject to escalation in the event of delinquency in the payment of the
dividends; as of December 31, 1996, the dividend rate had escalated to 16.86%
per share. Dividends can be paid on the Series A Preferred Stock at the
Company's discretion and the Series A Preferred Stock is redeemable at any time
at the option of the Company; such dividend and redemption rights are currently
restricted, however, by the indenture relating to the Series B Notes.
On July 29, 1994, the Company and California Public Employees'
Retirement System ("CalPERS") entered into a Series B Preferred Stock Purchase
and Class A Common Stock Warrant Agreement whereby the Company would have the
option, for a period of 30 months after July 29, 1994, to sell up to $60 million
of Series B Preferred Stock to CalPERS. On July 29, 1994, the Company sold
150,000 shares of the Series B Preferred Stock and 254,684 warrants to purchase
Class A Common Stock to CalPERS for $15 million. On October 31, 1994, the
Company sold 450,000 shares of Series B Preferred Stock and 764,053 warrants to
purchase Class A Common Stock to CalPERS for $45 million. Each warrant (exercise
price of $.001 per share) entitles CalPERS to purchase from the Company one
share of Class A Common Stock at any time. The Company may be required to issue
additional warrants to CalPERS to allow CalPERS to achieve a certain return on
its investment in the Company.
The Series B Preferred Stock is non-voting and, upon liquidation or
dissolution of the Company, the holders of the Series B Preferred Stock are
entitled to a preferential distribution from the assets legally available for
distribution to stockholders after the payment of all debts and liabilities of
the Company. As of December 31, 1996, such aggregate preferential distribution
would amount to $75.3 million, including accrued and unpaid dividends ($4.1
million).
Dividends on the Series B Preferred Stock are payable on January 2 and
July 1 of each year, subject to the dividend restrictions in the indenture
relating to the Series B Notes. The dividend rate, originally $10 per share, is
subject to escalation in the event of delinquency in
240
the payment of the dividends; as of December 31, 1996, the dividend rate had
escalated to $12.10 per share. The Company has the option to pay dividends in
either cash or additional shares of Series B Preferred Stock.
On February 25, 1997, the Company's Board of Directors declared a
dividend "in-kind" of $11.2 million to the Series B Preferred Stock shareholders
by issuing 111,910 shares of Series B Preferred Stock to shareholders of record
as of December 31, 1996. Accordingly, this "in-kind" dividend has been reflected
in the carrying amount of the Mandatorily Redeemable Series B Preferred Stock in
the accompanying consolidated balance sheet. Subsequently, the Company declared
an additional "in-kind" dividend of $5.3 million by issuing 53,485 shares of
Series B Preferred Stock to its Series B Preferred Stock shareholders as of
February 28, 1997.
The Series B Preferred Stock is subject to an optional redemption by the
Company. The Company must pay a premium of 6-1/2% if such redemption occurs
prior to July 29, 1997, and a 5% premium during the subsequent 24 months. Unless
earlier redeemed, the Company must redeem all Series B Preferred Stock on July
29, 2002. The Series B Preferred Stock also may be redeemed at the option of the
holder in certain circumstances. The terms of the Series B Preferred Stock
limit, among other things, (a) the issuance of additional capital stock, (b)
consolidations, mergers, transfers or sales of all or substantially all of the
Company's assets, (c) payment of dividends on and redemption of the Company's
capital stock, and (d) additional indebtedness.
On September 25, 1995, the Company and Princes Gate Investors, L.P. and
affiliates, investment partnerships managed by Morgan Stanley & Co. Incorporated
(collectively, the "Princes Gate Investors") entered into a Securities Purchase
Agreement, pursuant to which the Princes Gate Investors purchased, for an
aggregate sum of $35 million ($33.8 million net of commissions), 350,000 shares
of preferred stock designated Redeemable Convertible Preferred Stock, Series C
(the "Series C Preferred Stock") and 741,110 warrants to purchase Class A Common
Stock (the "Series B Warrants").
The Series C Preferred Stock is senior to the Company's Class A Common
Stock and Series A Preferred Stock and junior to the Company's Series B
Preferred Stock with respect to dividends and rights upon liquidation. The
Series C Preferred Stock is non-voting and, upon liquidation of the Company, the
holders of the Series C Preferred Stock are entitled to a preferential
distribution from the assets legally available for distribution to stockholders
after the payment of all debts and liabilities of the Company and all
liquidation payments to the holders of the Series B Preferred Stock, including
all accrued and unpaid dividends (the "Series C Redemption Amount"). As of
December 31, 1996, the Series C Redemption Amount was $40.3 million, including
accrued and unpaid dividends ($5.3 million).
Dividends on the Series C Preferred Stock, which are payable on
January 1, April 1, July 1 and October 1 of each calendar year, cumulate
at the rate of $12 per share per annum through March 24, 1999. The
241
dividend rate per share per annum increases according to the following
schedule:
March 25, 1999 to September 24, 1999 $13.00
September 25, 1999 to March 24, 2000 14.00
March 25, 2000 to September 24, 2000 15.00
September 25, 2000 to March 24, 2001 16.00
March 25, 2001 and thereafter 17.00
Under the terms of the Company's indenture relating to the Series B
Notes, dividends on the Series C Preferred Stock may not be paid until the
Series B Notes are paid in full and, under the Restated Certificate, dividends
on the Series C Preferred Stock are subject to the prior payment of dividends on
and, under certain circumstances, redemption of the Series B Preferred Stock.
At any time after March 24, 1999, the Princes Gate Investors, holding
not less than 66-2/3% of all Series C Preferred Stock, have the right to convert
the Series C Preferred Stock into shares of Class A Common Stock having a fair
market value, as defined, equal to 110% of the Series C Redemption Amount
on that date. After any such conversion, no new shares of Series C Preferred
Stock may be issued by the Company. Additionally, subject to certain limitations
imposed by the Restated Certificate and the Series B Notes, the Series C
Preferred Stock is redeemable at the option of the Company for an amount equal
to the Series C Redemption Amount on the date of any such redemption.
The terms of the Series C Preferred Stock, contain certain covenants
that, among other things, limit the Company's ability to (a) issue additional
shares of preferred stock, (b) incur additional indebtedness and (c)
consolidate, merge or sell substantially all of the Company's assets.
Each of the Series B Warrants entitles the holder thereof to purchase
one share of Class A Common Stock at an exercise price of $.01 per share. The
Company will be required to issue additional Series B Warrants upon the
occurrence of certain events as follows: If 1) the Company has not repurchased,
redeemed or converted all outstanding Series C Preferred Stock on or before
March 25, 1999, or 2) prior to March 25, 1999, an initial public offering has
occurred and all of the proceeds from such offering are not used to redeem
outstanding shares of Series C Preferred Stock, then on the earlier of (1) or
(2) above, additional Series B Warrants shall be issued, if Series C Preferred
Stock is still outstanding; provided, however, that at no time is the Company
required to issue more than an aggregate of 3,989,931 Series B Warrants.
In September 1995, the Company also issued an additional 125,000
warrants (exercise price of $.001 per share) to purchase Class A Common Stock to
the holders of the Company's Series B Preferred Stock. These warrants were
issued in exchange for the consent of the holders of the
242
Series B Preferred Stock to the issuance of the Series C Preferred Stock.
Warrants
In addition to the warrants issued to CalPERS and Princes Gate
Investors, the Company issued warrants to the purchasers of its senior secured
notes at the purchase price of $.02 per warrant. In the aggregate, the warrants
entitle the holders to purchase 350,000 shares of the Company's Class A Common
Stock at $.142 per share. The exercise price and the number of warrant shares
are both subject to adjustment in certain cases. The warrants are exercisable at
any time and, unless exercised, the warrants will automatically expire ten years
from the date of issuance.
The holders of the warrants have no voting or dividend rights. The
holders of the warrants are not entitled to share in the assets of the Company
in the event of liquidation or dissolution of the Company. In case of certain
consolidations or mergers of the Company, or the sale of all or substantially
all of the assets of the Company to another corporation, each warrant shall
thereafter be exercisable for the right to receive the kind and amount of shares
of stock or other securities or property to which such holder would have been
entitled as a result of such consolidation, merger or sale had the warrants been
exercised immediately prior thereto.
Stock Option Plans
At December 31, 1996, the Company has two fixed stock option plans for
employees, two stock option plans for nonemployees which principally includes
the distributors of the Company's products and a distributor stock purchase
plan. Generally, the Company's stock option plans grant options to purchase the
Company's Class A Common Stock and, in certain instances, the Company's Series A
Preferred Stock.
Under the 1993 Stock Option Plan, the Company may grant options to its
employees for up to 1.5 million shares of Class A Common Stock. Under the 1993
Special Stock Option Plan, the Company may grant options to its employees for up
to 200,000 shares of common stock and 20,000 shares of preferred stock. Under
these two fixed stock option plans, options generally become exercisable in
installments of 25% annually in each of the first through fourth anniversaries
of the grant date and have a maximum term of ten years. Under both plans, the
exercise price of each option equals the market price of the Company's
respective stock on the date of grant.
The Company's non-employee stock option plans include the 1994 Non-
employee Stock Option Plan ("NSOP") which authorizes up to 125,000 shares of
Class A Common Stock and the 1994 Distributor Stock Option Plan ("DSOP") which
authorizes up to 500,000 shares of Class A Common Stock. Under both of those
plans, the exercise price of each option equals the market price of the
Company's Common Stock on the date of grant with the options maximum term
equaling ten years. Under the NSOP, options generally become exercisable in
installments of 25% annually in each of the first through fourth anniversaries
of the grant date. Under the
243
DSOP, options generally become exercisable upon the achievement of a specified
performance target.
A summary of the Company's fixed and non-employee stock option plans as
of December 31, 1994, 1995 and 1996, and changes during the years ending on
those dates is as follows:
1994 1995 1996
---- ---- ----
Weighted Weighted Weighted
Average Average Average
Class A Shares Exercise Shares Exercise Shares Exercise
Common Stock (000's) Price (000's) Price (000's) Price
- ------------ ------ -------- ------- -------- ------- --------
Balance,
Beginning of year 971.5 $0.14 1,635.3 $3.09 1,822.2 $8.78
Granted 819.3 6.32 624.5 19.28 204.7 21.00
Exercised - - (330.5) 0.14 (123.0) 0.14
Lapsed (155.5) 0.85 (107.1) 9.66 (231.8) 11.57
--------- -------- --------
Balance,
End of year 1,635.3 3.09 1,822.2 8.78 1,672.1 10.53
==============================================================
1994 1995 1996
---- ---- ----
Weighted Weighted Weighted
Average Average Average
Series A Shares Exercise Shares Exercise Shares Exercise
Preferred Stock (000's) Price (000's) Price (000's) Price
- --------------- ------ -------- -------- -------- ------- --------
Balance,
Beginning of year 14,750 $19.88 14,775 $19.88 17,000 $19.88
Granted 3,025 19.88 3,250 19.88 - -
Exercised - - (525) 19.88 - -
Lapsed (3,000) 19.88 (500) 19.88 (3,250) 19.88
--------- ------- --------
Balance,
End of year 14,775 19.88 17,000 19.88 13,750 19.88
==============================================================
244
The following table summarizes information concerning the Company's
stock option plan's at December 31, 1996:
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life (years) Price Exercisable Price
$0.14 1,026,875 6.79 $0.14 260,250 $0.14
$7.50 132,880 7.44 $7.50 101,380 $7.50
$8.48 153,560 7.71 $8.48 74,918 $8.48
$13.77 119,800 7.90 $13.77 69,130 $13.77
$16.57 166,980 8.16 $16.57 76,491 $16.57
$20.13 108,200 8.41 $20.13 32,700 $20.13
$21.00 417,275 9.11 $21.00 69,070 $21.00
The Company applies APB Opinion 25 and related Interpretations in
accounting for its stock option plans. Accordingly, no compensation cost has
been recognized for its fixed stock option plans. Also, no compensation cost has
been recognized under the Company's non-employee stock option plans during 1994
and 1995, however, approximately $126,000 of compensation cost was recognized in
the accompanying consolidated statement of operations for the year ended
December 31, 1996 related to the non-employee stock option plans. Had
compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with SFAS No. 123, the Company's net loss and earnings per
share would have been increased to the following pro forma amounts (in
thousands, except per share amounts):
1996 1995
---- ----
Net loss As reported ($14,589) ($6,492)
Pro forma ($15,554) ($7,356)
Loss Per Share As reported ($3.90) ($2.24)
Pro forma ($4.00) ($2.35)
The fair value of each option is estimated on the date of grant using the
minimum value methodology promulgated by SFAS No. 123. The weighted average fair
value of options granted during 1996 and 1995 were $9.62 and $9.03,
respectively. This methodology is used as the Company's shares are not publicly
traded. In applying the minimum value methodology, the Company utilized a risk
free interest rate that varied between 5.63% and 7.50% for 1996 and 1995 grant
dates and expected lives of the options of 10 years for both 1996 and 1995.
245
Employees' Common Stock Grant Plan
The Company has an Employees' Common Stock Grant Plan of which 122,500
shares are reserved for issuance under this plan. No grants have been made
during 1996, 1995 and 1994.
Distributor Stock Purchase Plan
During 1993, the Company established a Stock Purchase Plan for its
distributors pursuant to which shares of Class A Common Stock and Series A
Preferred Stock were offered to the Company's distributors for a purchase price
of $.142 and $19.88, respectively, per share. As of December 31, 1996, 417,000
shares of Class A Common Stock and 39,450 shares of Series A Preferred Stock
purchased under this plan were outstanding. Shares purchased under this plan
vest on December 31, 1999, or earlier if certain criteria are met. As of
December 31, 1996, 342,040 shares of Class A Common Stock and 31,954 shares of
Series A Preferred Stock were vested. These shares are subject to repurchase by
the Company in the event that a distributor's association with the Company is
terminated or if the distributor is no longer operating as an exclusive sales
representative for the Company. The repurchase price shall be the distributor's
cost to purchase the shares until the shares vest; thereafter, the repurchase
price shall be at fair market value.
9. INCOME TAXES
Consolidated income (loss) before income taxes consists of the following
(in thousands):
1996 1995 1994
----------- ------------ -----------
United States $(10,525) $ (4,403) $(59,038)
Foreign (4,064) (470) 1,777
----------- ------------ -----------
$(14,589) $ (4,873) $(57,261)
=========== ============ ===========
The provision (benefit) for income taxes consists of the following (in
thousands):
1996 1995 1994
----------- ----------- ------------
Current - Foreign $ (1,278) $ 351 $ 574
Deferred (1,603) 2,167 (17,550)
Tax benefit of operating loss (1,495) (3,426) (5,179)
carryforward
Adjustment to valuation allowance 4,376 2,527 14,274
----------- ----------- ------------
$ - $ 1,619 $ (7,881)
=========== =========== ============
246
The income tax provision (benefit) differs from the amount computed by
applying the U.S. statutory federal income tax rate due to the following (in
thousands):
1996 1995 1994
---------- ---------- ---------
Income tax benefit at statutory rate $ (4,911) $ (1,657) $(19,469)
Adjustment to valuation allowance 4,376 2,527 14,274
State income taxes (415) (176) (2,385)
Foreign income taxes 104 162 (388)
Goodwill amortization 560 584 32
Other, net 286 179 55
---------- ---------- ----------
$ - $ 1,619 $ (7,881)
========== ========== ==========
The components of deferred taxes are as follows (in thousands):
1996 1995
------------ ------------
Deferred tax assets:
Operating loss carryforward $ 9,718 $ 7,544
Reserves and allowances 9,398 9,088
Intercompany profit on inventories 319 700
Other 5,294 3,910
----------- -----------
24,729 21,242
Valuation allowance (22,051) (17,675)
----------- -----------
$ 2,678 $ 3,567
=========== ===========
Deferred tax liabilities:
Intangible assets $ 1,700 $ 1,873
Depreciation 363 604
Other 615 1,090
----------- -----------
$ 2,678 $ 3,567
=========== ===========
The Company has provided a valuation allowance against its net deferred
tax assets because, given the Company's history of operating losses, the
realizability of these assets is uncertain. Management's assessment of the need
for a valuation allowance could change in the future based on the Company's
future operating results.
At December 31, 1996, the Company has a net operating loss carryforward
for U.S. federal income tax purposes of approximately $21.3 million which
expires in 2008 through 2011. Additionally, the Company has credit carryforwards
of approximately $646,000 which expire through 2010.
247
10. EMPLOYEE BENEFIT PLANS
The Company sponsors a defined contribution plan which covers employees
that are 21 years of age and over. The Company has the option to contribute
annually to the plan shares of Company stock determined by the Board of
Directors and will match employee's voluntary contributions at rates of 100% of
the first 2% of an employee's annual compensation, and 50% of the next 2% of an
employee's annual compensation. Employees vest in the Company's contributions
after 5 years. The Company's cost related to this plan was approximately $1.7
million, $1.7 million and $1.2 million, respectively, for the years ended
December 31, 1996, 1995 and 1994.
11. COMMITMENTS AND CONTINGENCIES
Lease Commitments
The Company leases certain equipment under capital leases and
noncancelable operating leases. The future annual minimum rental payments under
these leases are as follows (in thousands):
Capital Operating
Year Leases Leases
---- ----------- -----------
1997 $170 $ 622
1998 108 360
1999 84 253
2000 42 73
2001 33 5
Thereafter 8 -
----------- -----------
Total minimum lease payments 445 $ 1,313
===========
Less amount representing interest (67)
-----------
Present value of future lease payments $378
===========
Rental cost under operating leases for the years ended December 31,
1996, 1995 and 1994 was approximately $1.2 million, $1.3 million, and $1.0
million, respectively.
Concentration of Credit Risk
Substantially all of the Company's sales and trade receivables are
concentrated with hospitals and physicians. The Company maintains reserves for
potential credit losses on trade receivables, which are generally not
collateralized.
Legal Proceedings
Substantial patent litigation among competitors occurs regularly in
the medical device industry. The Company assumed responsibility for
248
certain patent litigation in which the Company and/or Dow Corning Corporation
and/or its former subsidiary, Dow Corning Wright Corporation (collectively,
"DCW") was a party. Those proceedings in which the Company was a defendant have
now been resolved.
DCW, pursuant to the Acquisition agreements, retains liability for
matters arising from conduct of DCW prior to the Company's acquisition on June
30, 1993, of substantially all the assets of the large joint orthopaedic implant
business of DCW. As such, DCW has agreed to indemnify the Company against all
liability for all products manufactured prior to the DCW Acquisition except for
products provided under the Company's 1993 agreement with DCW pursuant to which
the Company purchased certain small joint orthopaedic implants for worldwide
distribution. However, the Company was notified in May 1995 that DCW, which
filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code, would no
longer defend the Company in such matters until it received further direction
from the bankruptcy court. On December 2, 1996, DCW filed a proposed plan of
reorganization that provides that all commercial creditors will be paid 100% of
their claims, plus interest. The plan did not, however, indicate whether DCW
would affirm or reject the Acquisition agreements. Accordingly, there can be no
assurance that Dow Corning will indemnify the Company on any claims in the
future. Although the Company does not maintain insurance for claims arising on
products sold by DCW, management does not believe the outcome of this matter
will have a material adverse effect on the Company's financial position or
results of operations.
On October 25, 1996, the Company was notified that it had been sued by
Mitek Surgical Products, Inc. in the United States District Court for the
Northern District of California seeking damages for the alleged infringement of
its patent by the Company's ANCHORLOK(TM) soft tissue anchor. The Company has
denied the allegations and is defending the action.
On April 3, 1995, the Company (and Orthomet, Inc., a wholly owned
subsidiary at the time that has subsequently been merged with and into the
Company) was notified that it had been sued by Joint Medical Products
Corporation (which was purchased by Johnson & Johnson Professional, Inc.), in
the United States District Court for the District of Connecticut seeking damages
for the alleged infringement of its patent (the "'472 Patent") by certain of the
Company's acetabular cups and liners. Pending the resolution of an interference
proceeding in the U.S. Patent and Trademark Office regarding the '472 Patent by
British Technology Group Ltd. ("BTG"), such complaint was dismissed without
prejudice. In early November 1996, the Company was notified that the
interference proceeding was resolved, and that, the complaint has been refiled
(but not served). BTG has offered the Company a license of the '472 Patent and a
corresponding reissue patent. The Company believes that it has valid defenses to
claims of infringement of the '472 Patent and to the reissue patent.
The Company is not involved in any other pending litigation of a
material nature or that would have a material adverse effect on the Company's
financial position or results of operations.
249
Other
On October 7, 1994, the Company entered into a research and development
funding agreement with OsteoBiologics, Inc. ("OBI") based in San Antonio, Texas.
In exchange for the Company's $6.5 million funding commitment, OBI has granted
the Company (a) exclusive worldwide distribution rights for 15 years from the
date of commercialization of certain OBI orthopaedic products and (b) warrants
to purchase up to 1,252,848 shares of OBI common stock at $0.025 per share. In
1994, the Company expensed the $6.5 million commitment as research and
development expense. At December 31, 1996, the Company had paid all of its
funding obligations pursuant to this agreement.
On February 22, 1996, the Company entered into a Distribution Agreement
with a Japanese corporation whereby the Company received $3 million in exchange
for 60,000 shares of the Company's Class A Common Stock and the exclusive rights
to distribute the Company's products in Japan for an initial period of five
years, with a possible extension for an additional five years subject to the
achievement of certain sales goals. In connection with this Distribution
Agreement, the Company is amortizing $1,740,000 for the proceeds assigned to the
distribution rights to income ratably over 5 years. At December 31, 1996,
deferred income in the accompanying consolidated financial statements related to
this distribution right was $1,502,000.
During 1996, the Company decided to discontinue operations of certain
subsidiaries including Wright Medical Technology of Hong Kong Limited, Wright
Medical Technology do Brasil Importadora e Comercial Ltda, Wright Medical
Technology of Australia Pty Limited and Wright Medical Technology France
S.A.R.L. Discontinuance of those operations did not have a material effect on
the Company's consolidated operating results or financial position.
12. RELATED PARTY TRANSACTIONS
Stockholder Notes Receivable
As of December 31, 1996 and 1995, the Company has notes receivable from
stockholders aggregating approximately $1.0 and $1.0 million, respectively,
relating to purchases of the Company's common and preferred stock. On December
27, 1995, Herbert Korthoff, the Company's Chairman and then Chief Executive
Officer, and Barbara Korthoff repaid the outstanding principal balance of
$1,176,164 on 552,690 shares of Class A Common Stock and 55,269 shares of Series
A Preferred Stock purchased through a note on June 30, 1993. A new non-interest
bearing note was issued for the unpaid interest on the above note of $420,480.
Effective April 1, 1994, the Company repurchased 798,380 shares of Class A
Common Stock and 79,838 shares of Series A Preferred Stock from Herbert
Korthoff. The Company repurchased the shares at the same price at which such
shares had originally been sold to Mr. Korthoff. The repurchase of the shares
was accomplished through a $1.7 million reduction of the stock purchase note
receivable from Mr. Korthoff.
The remaining stockholder notes receivable bear interest at the
rate of 10% per annum, payable semi-annually. At the option of the
250
maker, the interest may be deferred and added to principal, and to date such
interest has been added to principal. The entire principal amount is due on June
30, 1998, subject to acceleration upon a sale of all or substantially all of the
business assets, or issued and outstanding capital stock of the Company or the
successful completion of an initial public offering by the Company of any of its
equity securities pursuant to a registration statement under the Securities Act
of 1933. The notes are secured by a pledge of the related preferred and common
stock. Approximately $61,644, $178,000, and $265,000 respectively, of interest
income relating to stockholder notes receivable was recorded by the Company
during the years ended December 31, 1996, 1995 and 1994.
Distributor Notes Receivable
The Company has notes receivable from its distributors relating
primarily to the purchase of instruments used by surgeons in the implantation of
the Company's products. The notes bear interest at variable rates ranging from
approximately 6% to 8% and generally are collateralized by the related
instruments. The outstanding balance on these notes was approximately $0.4
million and $8.6 million at December 31, 1996 and 1995, respectively, of which
the current portion (included in "other current assets" in accompanying balance
sheets) was $0.3 million and $1.5 million, respectively.
During 1996, the Company repurchased certain surgical instruments owned
by distributors at the lower of the instruments' fair value or the related
unpaid note balance. This repurchase was done to implement the instrument
program discussed in Note 3 to the consolidated financial statements.
The accompanying statements of operations for the years ended December
31, 1996, 1995 and 1994, include approximately $0.8 million, $2.4 million, and
$2.0 million, respectively, of net sales of instruments to distributors.
Typically, the Company has not reflected any gross margin on these instrument
sales.
Management Agreement
The Company has a management agreement with an affiliate of one of its
principal stockholders pursuant to which management fees of $360,000 were
incurred for the years ended December 31, 1996, 1995 and 1994.
13. SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Following is a summary of the Company's noncash investing and financing
activities for the year ended December 31:
1994
- Repurchased 798,380 shares of Class A Common Stock and 79,838 shares
of Series A Preferred Stock through a $1.7 million reduction of
stock purchase note receivable.
- Acquired Questus for approximately $4.4 million, of which
251
approximately $2.3 million was funded by the issuance of 169,630
shares of the Company's Class A Common Stock.
- Acquired certain intellectual property rights through incurrence of
related indebtedness of approximately $3.6 million.
1995
- None
1996
- Issued 111,910 shares of Series B Preferred Stock in the form of an
"in-kind" dividend payment aggregating $11.2 million.
- Repurchased surgical instruments from distributors totaling $6.8
million through the forgiveness of accounts owed by distributors to
the Company on such surgical instruments.
14. INDUSTRY SEGMENT AND FOREIGN OPERATIONS
The Company's operations are classified as a single industry segment.
Selected financial information by geographic area is as follows (in thousands):
United Elimi-
Year Ended December 31, 1994 States Foreign nations Total
- ----------------------------- ---------- --------- ----------- ----------
Net sales
Unaffiliated customers $ 72,963 $ 22,800 $ - $ 95,763
Intercompany 9,045 - (9,045) -
----------- ---------- ----------- ----------
Total $ 82,008 $ 22,800 $ (9,045) $ 95,763
----------- ---------- ----------- ----------
Operating loss $ (34,673) $ (11,452) $ (1,006) $ (47,131)
----------- ---------- ----------- ----------
Identifiable assets $ 137,597 $ 18,621 $ (1,667) $ 154,551
----------- ---------- ----------- ----------
Year Ended December 31, 1995
Net sales
Unaffiliated customers $ 109,046 $ 14,150 $ - $ 123,196
Intercompany 3,005 - (3,005) -
----------- ---------- ---------- ----------
Total $ 112,051 $ 14,150 $ (3,005) $ 123,196
----------- ---------- ---------- ----------
Operating income (loss) $ 5,308 $ 1,171 $ (176) $ 6,303
----------- ---------- ---------- ----------
Identifiable assets $ 159,871 $ 16,339 $ (1,839) $ 174,371
----------- ---------- ---------- ----------
Year Ended December 31, 1996
Net sales
Unaffiliated customers $ 108,125 $ 13,743 $ - $ 121,868
Intercompany 5,375 - (5,375) -
----------- ---------- ---------- ----------
Total $ 113,500 $ 13,743 $ (5,375) $ 121,868
----------- ---------- ---------- ----------
Operating income (loss) $ (774) $ (3,289) $ 1,008 $ (3,055)
----------- ---------- ---------- ----------
Identifiable assets $ 167,458 $ 5,761 $ (6,893) $ 166,326
----------- ---------- ---------- ----------
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Operating expenses not directly related to a particular geographic
segment have been allocated between segments in proportion to net sales.
15. SUBSEQUENT EVENT
On January 3, 1997, the Company entered into an agreement with Gary K.
Michelson, M.D., to purchase rights to patents, ideas and designs related to the
"MultiLock" design for an anterior cervical plating system. The purchase price
includes a payment of $120,000 due in four installments in 1997, as well as
royalties equal to 8% of the sales, net of commissions, of the locking cam
products. The Company guaranteed minimum royalties as follows:
04/01/98 - 03/31/99 $320,000
04/01/99 - 03/31/00 $480,000
04/01/00 - 03/31/01 $700,000
04/01/01 - 03/31/02 $1,000,000
For each of the annual periods commencing April 1, 2002 through March 31
of the subsequent year, and continuing for the longer of the period for which
the MultiLock products are being sold or 10 years from January 3, 1997, the
minimum royalty shall be $1.0 million.
The Company also entered into an agreement with Dr. Michelson to
purchase rights to patents, ideas and designs related to the "SingleLock" design
for an anterior cervical plating system. The purchase price includes a payment
of $100,000 due in 1997, as well as royalties equal to 8% of the net sales of
the SingleLock products. The Company guaranteed minimum royalties as follows:
10/01/98 - 03/31/99 $80,000
04/01/99 - 03/31/00 $200,000
04/01/00 - 03/31/01 $295,000
04/01/01 - 03/31/02 $425,000
04/01/02 - 03/31/03 $500,000
and years thereafter
Dr. Michelson agreed to provide exclusive continuing services as a
developer, product lecturer and general consultant for anterior cervical
plating. The Company is acquiring a $5,000,000 ten year term key man life
insurance policy on Dr. Michelson with the Company as beneficiary.
253
EXHIBIT INDEX
Does not include the documents incorporated by reference as delineated
by Item 14 of this Form 10-K.
10.25 Joint Venture Agreement with Tissue
Engineering, Inc.
11.1 Statements re: Computation of Earnings per
Share
12.1 Statement re: Computation of Ratios of
Earnings to Fixed Charges and Preferred
Dividends
21.1 Subsidiaries of the Company
23.2 Consent of Arthur Andersen LLP
254
Exhibit 10.25
Joint Venture Agreement with Tissue Engineering
JOINT VENTURE AGREEMENT
THIS JOINT VENTURE AGREEMENT (the "Agreement") is entered into as of the
12th day of July, 1996, by and between WRIGHT MEDICAL TECHNOLOGY, INC., a
Delaware corporation, having offices at 5677 Airline Road, Arlington, Tennessee
38002 ("Wright") and TISSUE ENGINEERING, INC., a Delaware corporation, having
offices at The Fargo Building, 451 D Street, Boston, Massachusetts 02210 (the
"Company").
WHEREAS, the Company has developed and owns technology to produce
collagen-based scaffolds which can be used, among other things, for ligament and
tendon reconstruction, for cartilage regeneration, and for use with calcium
phosphate/sulfate as a bone graft substitute (collectively, the "Technology");
and
WHEREAS, Wright and the Company desire to form a jointly owned Delaware
limited liability company (the "LLC") for the purpose of broadly commercializing
products for use in the treatment of musculoskeletal problems based on the
Technology (the "Products"), upon the terms and subject the conditions set forth
in this Agreement.
NOW, THEREFORE, in consideration of the premises and actual covenants
set forth herein and for other good and valuable consideration, the receipt and
sufficiency of which is hereby acknowledged, the parties hereby agree as
follows:
SECTION 1. DEFINITIONS. The following definitions shall apply to
this Agreement:
"Additional Note" shall have the meaning given to it in Section
3(C) hereof.
"Approved Marketing Expenses" for any period shall mean the total amount
of marketing expenses mutually agreed upon by Wright and the Company for such
period when Products become available for marketing. Within thirty (30) days
following the end of each Contract Year, Wright shall provide the LLC with a
written reconciliation of actual marketing expenses and the Approved Marketing
Expenses for such year. In the event the actual marketing expenses do not exceed
the Approved Marketing Expenses that had been returned to Wright that year, the
difference shall be added to Gross Billings for the month in which the
reconciliation is presented. Wright shall be solely responsible for any actual
marketing expenses that exceed the Approved Marketing Expenses for any year.
"Approved Per Unit Marketing Expenses" shall be calculated each Contract
Year and shall mean the Approved Marketing Expenses divided by the Expected
Minimum Unit Sales.
"Approved R&D Expenses" for any period shall mean the total amount of
research and development expenses mutually agreed upon by Wright and the Company
for such period. Within thirty (30) days following the end of each Contract
Year, the Company shall provide the LLC with a written
255
reconciliation of actual research and development expenses and the Approved R&D
Expenses for such year. In the event that the actual research and development
expenses do not exceed the Approved R&D Expenses that had been returned to the
Company that year, such difference shall be added to Gross Billings for the
month in which the reconciliation is presented. The Company shall be solely
responsible for any actual research and development expenses that exceed the
Approved R&D Expenses for any year, unless provision is made by the LLC for such
research and development Expenses and for other mutually agreed upon research
and development expenses to be paid by funds raised by the LLC.
"Budget" shall mean the annual budget of the LLC approved by Wright and
the Company, which shall include, among other things, budgets for sales
forecasts, Approved Marketing Expenses, Approved R&D Expenses, intellectual
property development, patent prosecution and maintenance expenses, pre-clinical
and clinical costs and expenses, administrative and accounting expenses;
provided that the initial budget for the LLC is attached hereto as Exhibit D.
"CGS" shall mean the Company's fully absorbed costs to manufacture each
Product sold.
"Commissions" shall mean the actual sales commissions to be paid by
Wright on the sale of the Products.
"Contract Year" shall mean each twelve month period commencing on
January 1 and ending on December 31; provided that the first Contract Year shall
commence upon execution of this Agreement and end on December 1, 1996.
"Expected Minimum Unit Sales" shall mean the Minimum Gross Billings
divided by the average selling price of the Product in the prior year.
"Expenses" shall mean (1) Commissions; provided, however, that in any
one month period those Commissions may not exceed twenty percent (20%) of the
Gross Billings; (2) the CGS; (3) Approved Per Unit Marketing Expenses; provided,
however, that such marketing expenses shall cease to be deducted when the
aggregate Approved Marketing Expenses for a given year have been repaid to
Wright; (4) Wright's shipping costs for Products sold if such costs are able to
be billed by Wright to the customer and if not otherwise included in CGS; (5)
Approved R&D Expenses, manufacturing scale-up and manufacturing expenses
incurred by the Company; (6) all costs and expenses of Wright associated with
pre-clinical animal studies and clinical studies; and (7) any other expenses
that Wright and the Company agree to deduct.
"Formation Date" shall have the meaning given to it in Section 3(A)
hereof.
"Gross Billings" shall mean the sum of (1) the gross sales price charged
by Wright, (2) excess Approved Marketing Expenses and (3) excess Approved R&D
Expenses.
"Initial Note" shall have the meaning given to it in Section
256
3(B)(1) hereof.
"License" shall mean the royalty free, exclusive and perpetual license
granted by the Company for the Technology for use in the musculoskeletal field,
excluding dental applications, to the LLC pursuant to a license agreement
substantially in the form of Exhibit A attached hereto.
"Minimum Gross Billings" shall have the meaning given to it in Section
7(B)(2) hereof.
"Net Profit" for any period shall mean the aggregate Gross Billings
minus Expenses.
"Proprietary Information" shall mean any information of either party or
the LLC that might reasonably be considered proprietary, secret, sensitive or
private, including but not limited to: (a) technical information, know-how,
data, techniques, discoveries, inventions, ideas, unpublished patent
applications, trade secrets, formulae, analyses, laboratory reports, other
reports, financial information, studies, findings, or other information relating
to the LLC or the Technology or methods or techniques used by the LLC, whether
or not contained in samples, documents, sketches, photographs, drawings, lists
and the like; (b) data and other information employed in connection with the
marketing of the Products, including cost information, business policies and
procedures, revenues and markets, distributors and customers, and similar items
of information whether or not contained in documents or other tangible
materials; or (C) any other information obtained by the any party to this
Agreement during the term hereof, that is not generally known to, and not
readily ascertainable by proper means by, third parties.
SECTION 2. PURPOSE OF THE LLC. The LLC will be established for the
purposes of commercializing products based on the Technology. It is expected
that the LLC initially will focus a large share of its efforts toward products
that can be manufactured using the Technology and commercialized in the near
future. It is also expected that an appropriate balance of longer term product
opportunities will be maintained, working to develop commercializable products.
The parties hereto agree to negotiate in good faith to enter into one or more
additional LLC agreements in the event transactions contemplated by this
Agreement result in additional product ideas.
SECTION 3. FORMATION OF LLC; FURTHER CAPITAL CONTRIBUTIONS;
ADDITIONAL AGREEMENTS OF THE PARTIES.
A. As soon as practicable following the execution of this Agreement, the
parties hereto shall cause the LLC to be formed as a limited liability company
pursuant to the laws of the State of Delaware by filing a certificate of
incorporation (the "Charter"). The date of such filing is hereinafter referred
to as the "Formation Date".
B. On the Formation Date:
1. Wright shall contribute to the LLC (a) initial
257
administrative, accounting and legal support in order to create the LLC and (b)
a promissory note in the amount of $1,500,000 (the "Initial Note"), which
Initial Note shall be drawn down on demand by the LLC in accordance with the
Budget, in exchange for issuance by the LLC on the Formation Date of 49% of the
validly issued, fully paid and nonassessable shares of capital stock of the LLC
issued and outstanding on the Formation Date.
2. The Company shall contribute to the LLC the License to the
Technology in exchange for issuance by the LLC on the Formation Date of 51% of
the validly issued, fully paid and nonassessable shares of capital stock of the
LLC issued and outstanding on the Formation Date.
3. Wright and the Company shall execute a shareholders
agreement substantially in the form of Exhibit B attached hereto.
C. Wright hereby agrees to make additional funding contributions to the
LLC, in furtherance of the LLC, in the amount of $1,500,000 on each of the first
and second annual anniversary of the Formation Date; provided that each such
obligation shall be satisfied by delivering to the LLC a promissory note in the
amount of $1,500,000 (the "Additional Note"). To the extent that the LLC is able
to raise its own capital, or arrange for its own financing, Wright shall be able
to charge the LLC reasonable fees reflecting its fully absorbed cost for
providing administrative, accounting, legal, regulatory and clinical support
provided to the LLC and, in addition to the research and development provided
pursuant to the Budget for the first three years, beginning on the four year
anniversary of the execution of this Agreement, the Company shall be able to
charge the LLC for research and development support and support of product
manufacturing at normal commercial rates for such services.
D. The Company hereby agrees to grant to Wright an irrevocable voting
proxy for that number of shares of capital stock of the LLC equal to 1% of the
issued and outstanding stock of the LLC on the Formation Date, it being the
intent of the parties hereto that the Company and Wright each have a right to
vote 50% of the issued and outstanding stock of the LLC at all times; provided,
however, that in the event that Wright is a party to any agreement that
prohibits it from exercising such voting proxy, such proxy shall be granted to
an independent third party mutually acceptable to both Wright and the Company;
and provided, further, that Wright shall have the option to purchase such 1%
interest for $1.00 at anytime following the Formation Date. Furthermore, the
Company hereby agrees to take all action necessary to ensure that any such proxy
continues in perpetuity, including without limitation, executing subsequent
voting proxy upon the expiration of any existing proxy under applicable Delaware
law or, at the request of Wright, entering into a voting trust to effectuate the
purposes set forth in this Section 3(D).
SECTION 4. CORPORATE GOVERNANCE; MANAGEMENT.
A. Except as otherwise required by law or as provided in the
Charter, responsibility for the management, direction and control of the
LLC shall be vested in the Board of Directors of the LLC. The Charter
258
shall provide for the election of four directors.
B. The directors of the LLC shall be elected annually at annual meetings
of the stockholders of the LLC. It is understood and agreed by the parties
hereto that two of the directors of the LLC shall be individuals nominated by
Wright and two of the directors of the LLC shall be individuals nominated by the
Company. Each of the parties hereto covenants and agrees to vote its shares of
stock of the LLC to cause the election of the directors nominated in accordance
with the foregoing. In the event of the death, incapacity, resignation or
removal of a director prior to the end of his or her term, each of the parties
hereto agrees to vote its shares of stock so as to appoint as his or her
replacement a director nominated by the party hereto who nominated the director
whose death, incapacity, resignation or removal was the cause of such vacancy.
C. Wright and the Company shall take all actions necessary or
appropriate to ensure that the Charter accurately reflects the
arrangements set forth in this Section 4.
D. The management of the LLC shall be comprised of officers designated
by the Board of Directors of the LLC. Each of the parties hereto hereby
covenants and agrees to cause the directors of the LLC nominated by it to cast
their votes so as to appoint as officers of the LLC individuals who qualify
under the foregoing provisions of this Section 4(D). In the event of death,
incapacity, resignation or other removal of an officer prior to the end of his
or her term, each of the parties hereto agrees to cause the directors of the LLC
to cast their votes so as to appoint his or her replacement a nominee who
qualifies under said foregoing provisions of this Section 4(D).
E. Notwithstanding anything to the contrary contained herein, the
parties hereto hereby agree to use their best efforts to avoid the occurrence of
any deadlock and further agree to use their best efforts to resolve any deadlock
as expeditiously as possible.
F. The parties hereto agree that the Board of Directors of the LLC shall
meet at least once each calendar quarter at such time and place acceptable to
all directors, and at each annual meeting of the Board of Directors, an annual
operating Budget of the LLC shall be adopted.
G. If the parties are unable to agree at any Board of Directors' meeting
to act upon a resolution approving the LLC's annual operating plan and Budget,
the parties hereto agree that a top-level meeting be convened between the
parties, attended by corporate officers of each party with decision-making
authority regarding the dispute, in order to attempt in good faith to resolve
the matter. At such meeting each of the parties hereto will use its best efforts
to resolve the deadlock and such meeting shall continue until a resolution is
achieved.
SECTION 5. RESEARCH AND DEVELOPMENT ACTIVITIES.
A. Wright will use its best efforts to obtain regulatory approval
to sell and distribute the Products. In connection therewith, Wright
259
and the Company will meet, discuss and formulate a plan for Wright to fund
pre-clinical animal studies and clinical trials. Wright and the Company agree to
establish a clinical trials committee (the "CTC"), comprised equally of members
from Wright and the Company. The CTC will design and supervise the clinical
trials and shall have the full authority to direct the conduct of such clinical
trials. The CTC will operate by consensus, however, in the event the members of
the CTC cannot unanimously agree upon any given matter (other than matters
related to the funding of the clinical trials), such matter shall be referred to
and resolved by an oversight committee comprised of an equal number of
independent members from the respective scientific advisory boards of Wright and
the Company.
B. Wright agrees that it shall use commercially reasonable efforts to
assist and consult with the Company with respect to financial, accounting,
regulatory, engineering and manufacturing matters relating to the Products.
C. The LLC shall use the Company exclusively for research and
development services; provided that in the event the Company ceases to provide
such research and development services, the LLC shall be permitted to find
alternatives sources of research and development services.
D. (1) On the fourth anniversary of this Agreement, the Company shall
provide research and development services to the LLC and (2) upon commencement
of production of any Products, the Company shall provide manufacturing services,
each on financial terms to be mutually agreed upon by the Company, the LLC and
Wright.
SECTION 6. DISTRIBUTION RIGHTS; INTELLECTUAL PROPERTY RIGHTS.
A. In furtherance of the LLC, the Company hereby agrees to cause the LLC
to grant and convey to Wright the world-wide exclusive rights to sell, market,
distribute and conduct all incidental and necessary activities thereto with
respect to the Products pursuant to a distribution agreement substantially in
the form of Exhibit C attached hereto.
B. The Company shall own all patents associated with the Technology;
provided that the Company hereby grants the LLC a royalty-free license to the
Company's intellectual property to the extent necessary to make, use and sell
any Product, including without limitation, any and all patents and registered
trademarks, which license shall be exclusive for musculoskeletal use. Such
license shall automatically transfer to any successors in interest of the LLC.
Wright shall have the right to develop and own trademarks and tradenames for the
sale of the Product; provided that Wright shall undertake to acknowledge in any
Product literature that the Company participated in the invention of such
Product. Any intellectual property developed by either party, or by any third
party, pursuant to work commissioned as an Approved R&D Expense shall be owned
by the LLC. Patent prosecution and maintenance costs associated with such
intellectual property shall be paid by the LLC. Research and development
conducted by either party,
260
independent of this Agreement, or not commissioned as an Approved R&D Expense,
and the intellectual property associated therewith, shall be owned by the party
conducting such research and development.
SECTION 7. PROFIT SHARING; SALES; FORECASTS, ETC.
A. Profit Sharing. The LLC shall pay each of Wright and the Company
fifty percent (50%) of all Net Profits, if any, on the sale of any Products
during each month; provided that, if in any month Expenses exceed Gross
Billings, such excess Expenses shall be carried forward and deducted in the
following month on a pro rata basis consistent with the percentage of Expenses
incurred and paid that month to Wright and the Company respectively. The Net
Profit calculation shall be conducted by Wright, and the LLC shall tender any
payment to the Company and Wright, within 90 days of the end of each month.
B. Sales. Wright hereby agrees to use commercially reasonable
efforts to promote the Products in accordance with the Budgets.
C. Forecasts. Wright shall provide quarterly sales forecasts
that will include its best forecast for sales in the succeeding three
(3) months as well as projected sales for the succeeding twelve (12)
months.
D. Orders and Receivables. Wright shall take all orders for the
Products. Upon notification from Wright, the Company shall be responsible for
promptly delivering such Products directly to the customer or Wright, as
directed by Wright from time to time. The Company shall provide the Product
packaged and sterile according to Wright's packaging instructions. Wright shall
be responsible for all billing and collections. Freight shall be shipped F.O.B.
the Company and shall be added by Wright to all billings to customers, if
acceptable to the marketplace.
SECTION 8. ACCOUNTING AND GENERAL REPORTING.
A. The accounting period of the LLC shall commence on January 1 of each
year end on December 31 of the following; provided that the first accounting
period of the LLC shall commence as of the date this Agreement is executed and
end on the next following December 31.
B. Wright shall be responsible for keeping all books and records of the
LLC in accordance with sound and generally accepted accounting principles
applicable the LLC and corporate practices consistently applied. Wright shall
make and keep books, records and accounts that in reasonable detail accurately
and fairly reflect the transactions of the LLC.
C. Wright shall prepare monthly, quarterly and annual financial
statements of the LLC. Such financial statements shall be prepared in accordance
with generally accepted accounting principles. Wright shall submit such
statements to the Company as soon as practicable (but not later than 30 days in
the case of monthly and quarterly financial statements and 60 days in the case
of annual financial statements) after the end of each period.
261
D. Each party shall have the right, upon 10 days notice, to inspect the
financial records of the other party and the LLC only as they relate to the
calculation of Expenses (including without limitation, commissions, Approved
Marketing Expenses), Gross Billings and the calculation of Net Profit. All
materials reviewed and all materials prepared by the other party based upon the
audit shall remain confidential and not be used for any purpose other the
operation or enforcement of this Agreement.
SECTION 9. PROPRIETARY INFORMATION.
A. All business, technical, research and development and financial
information and materials containing such business information provided by the
parties to each other, including without limitation, lists of present or
prospective customers or vendors or of persons that have or shall have dealt
with the respective parties hereto, customer requirements, preferences and
methods of operation, management information reports and other computer
generated reports, pricing policies and details, details of contracts,
operational methods, plans or strategies, business acquisition plans, new
personnel acquisition plans, product information and samples, technology,
know-how, patent applications, designs and other business, technical, research
and development and financial affairs learned heretofore or hereafter, are and
shall be treated as confidential. Each party agrees for itself and on behalf of
its directors, officers, employees and agents to whom such information and
materials are disclosed, that it and they shall keep such information and
materials confidential and retain them in strictest confidence both during and
after the term of this Agreement. Such information and materials shall not be
disclosed by either party to any person except to its officers and employees
requiring such information or materials to perform services pursuant to this
Agreement and except to other persons under a confidentiality agreement with
either party protecting such information from disclosure. Each party
acknowledges and agrees that it shall be liable to the other for damages caused
by any breach of this provision or by any unauthorized disclosure or use of such
confidential information and materials by its officers and employees or third
parties to whom unauthorized disclosure was made. In addition to any other
rights or remedies that may be available to each party, each party shall be
entitled to appropriate injunctive relief or specific performance against the
other or its officers and employees to prevent unauthorized disclosure of such
confidential information and materials or other breach of this provision. Each
party acknowledges and agrees that such unauthorized disclosure or other breach
of this provision will cause irreparable injury to the other party and that
money damages will not provide an adequate remedy. Each party shall be entitled
to recover from the other its costs, expenses and attorneys' fees incurred in
enforcing its rights under this Section 9. Each party shall return to the other
all such information and materials covered under this Section 9 and received
pursuant to this Agreement and all copies thereof immediately upon the
termination of this Agreement.
B. This obligation of confidentiality shall not apply to any information
that (1) was known to the receiving party at the time of receipt as evidenced by
tangible records; (2) was in the public domain at the time of receipt; (3)
becomes publicly available through no fault
262
of the party obligated to keep it confidential; (4) such party legitimately
learns from third parties who are under no obligation of confidentiality with
respect to the information; or (5) is required by applicable law or court order
or other mandatory legal process to be disclosed.
C. The provisions of this Section 9 shall survive the termination
or expiration of this Agreement.
SECTION 10. OPERATION OF THE LLC.
A. The Company shall provide the LLC with product research and
development services, engineering support, patent services, as well as
manufacture the Products for sale by the LLC, all pursuant to the Budget of
Approved R&D Expenses. As set forth in the Budget, the Company hereby agrees to
provide continuing research and development support necessary to meet customer
demand, technological advances and as may reasonably be requested by Wright, and
employees of the Company shall be regularly available to consult and work with
the LLC and Wright on such research and development. In addition, the Company
shall manufacture and supply all Products necessary for the conduct of the LLC's
business; provided that the LLC may use an alternative manufacturer or supplier
that it determines is more cost effective than the Company. In order to receive
the necessary funding for the conduct of all Approved R&D Expenses and all other
Expenses set forth in the Budget, the Company shall be allowed to draw down upon
the Initial Note on the first of each month an advance of $100,000, and within
seven days thereafter provide a reconciliation of previous months expenditures
and the balance of the account to date. This advance shall be transferred by
wire directly to a segregated non-commingle operating account of the Company by
the 1st of the month. If during any month the reconciliation reflects a credit
balance in excess of $10,000, or if a large purchase is anticipated exceeding
$10,000, this monthly advance amount may be adjusted accordingly by mutual
agreement between Wright and the Company.
B. Wright shall provide the LLC with administrative services, accounting
services and marketing service, all pursuant to the Budget of Approved Marketing
Expenses. In addition, Wright shall be fully responsible for any and all
regulatory approvals necessary for the public sale and marketing of the Product
and all labeling and warnings associated with the Product. The Company promptly
shall provide Wright notice of any and all claims from third parties regarding
any of the Products, including events that may be reportable as an under any
current or future Food and Drug Administration MDR (medical device reporting)
regulations. Upon request, Wright shall consult with the Company regarding,
and/or provide the Company with proof of any regulatory approvals. In order for
Wright and the Company to be reimbursed for expenses detailed in Section 3(C)
hereof, and for those Approved Marketing Expenses and all other Expenses set
forth in the Budget, Wright and the Company shall provide the LLC with monthly
invoices, which invoices shall set forth in reasonable detail the services
provided and which shall be paid within 15 days of receipt by the LLC.
C. Wright shall be the exclusive distributor of all Products,
263
and shall be entitled to distribute the Products in a manner consistent
with the distribution of its own products.
D. The LLC shall be managed in accordance with its Budget and detailed
business plans. In accordance with the initial Budget, the LLC shall be
permitted to draw down the Initial Note upon demand in amounts equal to
approximately $800,000 for direct expenses and approximately $700,000 for
indirect expenses. In addition, the LLC shall be permitted to draw down upon
each Additional Note in amounts necessary to fund operations.
SECTION 11. COVENANTS OF THE PARTIES.
A. Except as otherwise expressly provided herein, all costs and expenses
incurred in connection with the preparation and execution of this Agreement and
the transactions contemplated hereby, including without limitation, attorneys'
fees and advisors' fees, if any, will be paid by the party incurring such costs
and expenses
B. Each of the parties hereby agree to use all reasonable efforts to
take, or cause to be taken, all actions and to do, or cause to be done, all
things necessary, proper or advisable under applicable laws, rules and
regulations to consummate and make effective the transactions contemplated by
this Agreement, including without limitation, any state or federal regulatory
filings. In the event that at any time after the execution of this Agreement,
further action is necessary or desirable to carry out the purposes of this
Agreement, the proper officers or directors of each of the parties shall take
such necessary action.
C. Upon execution of this Agreement, and continuing during its term, the
Company shall provide the LLC access to, or copies of, all documents and things
in the Company's control which relate to the Products and are necessary for the
LLC to conduct its business, including without limitation, obtaining regulatory
approval for any Product.
D. The Company hereby agrees to use its reasonable efforts during the
term of this Agreement to actively seek to develop the Products and to make
prudent and efficient use of the Initial Note and Additional Note, as well as
its own research and development expenditures. As used in this Agreement, the
term "best efforts" shall mean the commercially reasonable efforts that a
prudent person desiring to achieve a particular result would use in order to
ensure that such result is achieved as expeditiously as possible.
E. Each of the parties hereto hereby agrees to at all times conduct its
efforts hereunder in strict compliance with all applicable federal, state and
local laws and regulations and with the highest government standards.
F. Each of the parties hereto hereby agrees to use its best efforts to
arrange for independent financing for the LLC; provided, that in the event that
the LLC obtains such independent financing, the parties hereto hereby agree to
cause the LLC to distribute the first $1,000,000 of any such proceeds to Wright
as a return of its Initial
264
Capital Contribution to the LLC.
SECTION 12. LIABILITY.
A. The Company shall indemnify and hold harmless Wright from all
liability, damages, costs and expenses (including reasonable attorneys' fees)
incurred as a result of any claims, actions, judgments and demands for injuries
to persons or property arising from any and all design or manufacturing defects
in the Products (collectively, a "Claim"), and for any conduct of the Company,
but not for claims, actions, judgments, and demands arising from Wright's
negligence, gross negligence, or willful misconduct with respect to the sale and
distribution of Products.
B. Wright shall indemnify and hold harmless the Company from any Claim
arising from Wright's negligence, gross negligence, or willful misconduct with
respect to the sale and distribution of Products.
C. The provisions of paragraphs 12(A) and 12(B) hereof shall
survive the expiration and any termination of this Agreement.
D. Upon commercialization of Products, the LLC shall carry liability
insurance regarding the Products in an amount consistent with industry practice,
and each of the Company and Wright shall carry commercially reasonable amounts
of insurance commensurate with their respective obligations under this Agreement
(including without limitation, its indemnification obligations) and support of
the LLC's operations.
E. With respect to any actual or potential Claim or demand or
commencement of any action, or the occurrence of any other event, relating to
any Claim against which a party hereto is indemnified (the "Indemnified Party")
by the other party (the "Indemnifying Party") under this Section 9:
1. Promptly after the Indemnified Party first receives written
documents pertaining to the Claim, or if such Claim does not involve a third
party Claim (a "Third Party Claim"), promptly after the Indemnified Party first
has actual knowledge of such Claim, the Indemnified Party shall give notice to
the Indemnifying Party of such Claim in reasonable detail, stating the amount
involved, if known, together with copies of any such written documentation.
2. The Indemnifying Party shall have no obligation to indemnify the
Indemnified Party with respect to any Claim if the Indemnified Party fails to
give the notice with respect thereto in accordance with this Section 9.
3. If the Claim involves a Third Party Claim, then the Indemnifying
Party shall have the right, at its sole cost, expense and ultimate liability
regardless of the outcome, and through counsel of its choice (which counsel
shall be reasonably satisfactory to the Indemnified Party), to litigate, defend,
settle or otherwise attempt to resolve such Third Party Claim; provided,
however, that if in the Indemnified Party's reasonable judgment a conflict of
interest may exist between the Indemnified Party and the Indemnifying Party with
respect to
265
such Third Party Claim, then the Indemnified Party shall be entitled to select
counsel of its own choosing, reasonably satisfactory to the Indemnifying Party,
in which event the Indemnifying Party shall be obligated to pay the reasonable
fees and expenses of such counsel. Notwithstanding the preceding sentence, the
Indemnified Party may elect, at any time and at the Indemnified Party's sole
cost, expense and ultimate liability, regardless of the outcome, and through
counsel of its choice, to litigate, defend, settle or otherwise attempt to
resolve such Third Party Claim. If the Indemnified Party so elects (for reasons
other than the Indemnifying Party's failure or refusal to provide a defense to
such Third Party Claim), then the Indemnifying Party shall have no obligation to
indemnify the Indemnified Party with respect to such Third Party Claim, but such
disposition will be without prejudice to any other right the Indemnified Party
may have to indemnification under this Section 9, regardless of the outcome of
such Third Party Claim. If the Indemnifying Party fails or refuses to provide a
defense to any Third Party Claim, then the Indemnified Party shall have the
right to undertake the defense, compromise or settlement of such Third Party
Claim, through counsel of its choice, on behalf of and for the account and at
the risk of the Indemnifying Party, and the Indemnifying Party shall be
obligated to pay the costs, expenses and reasonable attorneys' fees incurred by
the Indemnified Party in connection with such Third Party Claim. In any event,
Wright and the Company shall fully cooperate with each other and their
respective counsel in connection with any such litigation, defense, settlement
or other attempted resolution.
SECTION 13. TERM AND TERMINATION.
A. The term of the Agreement shall commence as of the date of execution
of this Agreement and unless this agreement is terminated earlier pursuant to
the provisions hereof or otherwise, shall expire upon dissolution of the LLC.
During the term that this Agreement remains in effect, the Company and Wright
agree not to sell or distribute any other product line similar to the Products
for use in the musculoskeletal area without the consent of the other party;
provided, however, that this restriction shall not apply to any product line
incidentally acquired by either company through the purchase of another entity
and subsequently contributed to the LLC, Wright's ownership interest in
OsteoBiologics, Inc. or the sale or distribution by Wright of products developed
by OsteoBiologics, Inc.
B. In addition to other events of Termination set forth in this
Agreement, this Agreement shall terminate in the following events:
1. If either party breaches a material term or provision of this
agreement and the breaching party fails to cure the breach within 180 days after
notice thereof, the non-breaching party may terminate this Agreement, with such
termination effective upon expiration of the 180 day period.
2. If any governmental authority limits the ability of the Company
to manufacture or Wright to sell the Products in any material respect, either
party may terminate this agreement by giving written notice of termination for
such reason to the other party, such
266
termination to be effective upon the giving of such notice.
C. Upon the expiration or termination of this Agreement, Wright shall
have no right to order or purchase Products from the Company or the LLC, but may
dispose of its inventory of the Products through normal channels. Upon the
termination of this Agreement, all intellectual property owned by either party,
but licensed to the LLC, shall, subject to the terms of any applicable license
agreement, remain property of the respective party.
SECTION 14. MISCELLANEOUS.
A. Should any provision of this agreement be determined by a court
having jurisdiction over the parties and the subject matter to be illegal or
unenforceable in such jurisdiction, the parties agree that such determination
shall not affect or impair the validity or enforceability of such provision in
any other jurisdiction or the validity or enforceability of any other provision.
The determination by a court having jurisdiction over the parties and the
subject matter that any provision of this agreement is illegal or unenforceable
in such jurisdiction shall also not affect the validity or enforceability of the
other provisions of the agreement in that jurisdiction.
B. If a claim for indemnification arises under this agreement, the
indemnified party shall give the indemnifying party prompt written notice of any
event which might give rise to a claim for indemnification, specifying the
nature of the possible claim and the amount believed to be involved. If the
claim for indemnification arises from a claim or dispute with any third person,
the indemnifying party shall have the right, at its own expense, to defend
and/or settle such claim or dispute, and the indemnified party shall generally
cooperate fully in any such defense, but at no out-of-pocket cost to the
indemnified party.
C. In the event that either party is unable to carry out its obligations
under this agreement due to force majeure (including, without limitation, acts
of God; war; riot; fire; flood; explosion; labor disputes; embargoes; or
unavailability or shortages of raw materials, bulk, equipment or transport), the
failure so to perform shall be excused and not constitute a default hereunder
during the continuation of the intervention of such force majeure. The party
affected by such force majeure shall resume performance as promptly as
practicable after such force majeure has been eliminated. Notwithstanding the
foregoing, in the event either party is unable to carry out its obligations
hereunder by reason of such force majeure for a period of 180 days or more, than
either party may at any time thereafter during the continuation of such force
majeure terminate this agreement upon notice to the other party setting forth
the circumstances of such force majeure.
D. This agreement is binding upon and inures to the benefit of
the parties hereto and their respective permitted successors and
assigns.
E. This agreement, including the Exhibits annexed hereto,
267
constitutes the entire agreement between the parties with reference to the
subject matter hereof and supersedes all previous agreements, representations,
memoranda and undertakings whether oral or written, between the parties with
respect to the subject matter hereof and may not be changed without the written
consent of the parties.
F. Except as provided for in Section 4(F), any disputes regarding this
contract between the parties shall be settled by binding arbitration under the
rules of the American Arbitration Association. Each party shall pick a single
temporary arbitrator which two arbitrators will then choose the single
arbitrator before whom the dispute shall be heard. The dispute shall be heard
before that single arbitrator in Memphis, Tennessee, if initiated by the Company
and in Boston, Massachusetts, if initiated by Wright.
G. All notices and reports required or permitted to be given under this
agreement shall be deemed validly given and made if in writing and delivered
personally (as of such delivery) or sent by registered or certified mail,
postage prepaid, return receipt requested (as of ten (10) days after deposit in
the mail) or sent by facsimile or overnight courier service, charges prepaid (as
of the date of confirmed receipt) to the party to be notified in care of its
General Counsel at its address (or facsimile number if sent by facsimile) first
set forth above. Either party may, by notice to the other, change its address
and facsimile number for receiving such notices or reports.
H. This agreement shall be construed in accordance with and
governed by the laws of Tennessee without regard to its principles of
conflicts of laws.
I. Nothing contained in this Agreement shall be deemed to constitute
either party as the agent for the other, or to establish a fiduciary
relationship of any kind between the parties.
268
IN WITNESS WHEREOF, the parties hereto have executed and delivered this
Agreement as of the day and year first above written.
WRIGHT MEDICAL TECHNOLOGY, INC.
By: /s/Jon A. Brilliant
Jon A. Brilliant
Assistant General Counsel
TISSUE ENGINEERING, INC.
By: /s/Eugene Bell
Eugene Bell
CEO & President
269
Exhibit 11
Earnings Per Share
Exhibit 11.1
WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE
(in thousands, except loss per share)
Years Ended
--------------------------------------------------------------------------
December 31, 1996 December 31, 1995 December 31, 1994
--------------------- ---------------------- ---------------------
Net loss $ (14,589) $ (6,492) $ (49,380)
Dividends on preferred stock (14,251) (10,455) (3,447)
Accretion of preferred stock discount (6,458) (2,836) (339)
--------------------- ---------------------- ---------------------
Net loss applicable to common
and common equivalent shares $ (35,298) $ (19,783) $ (53,166)
===================== ====================== =====================
Weighted average shares of
common stock outstanding (a) 9,059 8,825 8,717
===================== ====================== =====================
Loss per share of common stock $ (3.90) $ (2.24) $ (6.10)
===================== ====================== =====================
<FN>
(a) Because of the net loss applicable to common stock, the assumed exercise
of common stock equivalents has not been included in the computation of
weighted average shares outstanding because their effect would be
anti-dilutive.
</FN>
270
Exhibit 12.1
Ratio of Earnings to Fixed Charges
Exhibit 12.1
WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND PREFERRED DIVIDENDS
(in thousands, except ratios)
(unaudited)
Years Ended December 31,
----------------------------------------------------
1996 1995 1994
-------------- -------------- --------------
Earnings:
Loss before income taxes $ (14,589) $ (4,873) $ (57,261)
Add back: Interest expense 10,718 10,899 9,311
Amortization of debt issuance cost 1,361 1,036 829
Portion of rent expense representative of interest factor 459 451 349
-------------- -------------- --------------
Earnings (loss) as adjusted $ (2,051) $ 7,513 $ (46,772)
============== ============== ==============
Fixed charges:
Interest expense $ 10,718 $ 10,899 $ 9,311
Amortization of debt issuance cost 1,361 1,036 829
Portion of rent expense representative of interest factor 459 451 349
-------------- -------------- --------------
$ 12,538 $ 12,386 $ 10,489
============== ============== ==============
Preferred dividends (grossed up to pretax equivalent basis): $ 14,251 $ 16,863 $ 3,997
Accretion of preferred stock (grossed up to pretax equivalent basis): 6,458 4,573 394
-------------- -------------- --------------
$ 20,709 $ 21,436 $ 4,391
============== ============== ==============
Ratio of earnings to fixed charges (a) (a) (a)
============== ============== ==============
Ratio of earnings to fixed charges, preferred dividends and accretion of
preferred stock (b) (b) (b)
============== ============== ==============
(a) Earnings were inadequate to cover fixed charges by $14.6 million, $4.9
million, and $57.3 million, respectively, for the years ended December 31,
1996, December 1995, and December 31, 1994.
(b) Earnings were inadequate to cover fixed charges, preferred dividends and
accretion of preferred stock by $35.3 million, $26.3 million, and $61.7
million respectively, for the years ended December 31, 1996, December 31,
1995, and December 31, 1994. Certain of the preferred dividends are, at
the option of the Company, payable in kind.
271
Exhibit 21.1
Subsidiaries of the Company
Exhibit 21.1
SUBSIDIARIES OF THE COMPANY
- - Wright Medical Technology Canada Ltd.
- - OrthoTechnique, S.A.
272
Exhibit 23.2
Consent of Independent Public Accountants
Exhibit 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the
incorporation of our report included in this Form 10-K, into the Company's
previously filed Form S-8 Registration Statements File Nos.
33-73232 and 33-73230.
Memphis, Tennessee,
March 21, 1997
273
EX-27
FDS --
ARTICLE 5
LEGEND
This schedule contains summary financial information extracted from the
Consolidated Financial Statements and is qualified in its entirety by
reference to such financial statements.
/LEGEND
MULTIPLIER 1000
CURRENCY U.S. dollars
TABLE
S C
PERIOD-TYPE 12-MOS
FISCAL-YEAR-END DEC-31-1996
PERIOD-START JAN-01-1996
PERIOD-END DEC-01-1996
EXCHANGE-RATE 1
CASH 910
SECURITIES 0
RECEIVABLES 18,289
ALLOWANCES 125
INVENTORY 59,107
CURRENT-ASSETS 83,516
PP&E 33,659
DEPRECIATION 25,124
TOTAL-ASSETS 166,326
CURRENT-LIABILITIES 33,044
BONDS 84,428
PREFERRED-MANDATORY 9
PREFERRED 0
COMMON 10
OTHER-SE 58,487
TOTAL-LIABILITY-AND-EQUITY 166,326
SALES 121,868
TOTAL-REVENUES 121,868
CGS 44,433
TOTAL-COSTS 44,433
OTHER-EXPENSES 80,077
LOSS-PROVISION (2,642)
INTEREST-EXPENSE 11,947
INCOME-PRETAX (14,589)
INCOME-TAX 0
INCOME-CONTINUING (14,589)
DISCONTINUED 0
EXTRAORDINARY 0
CHANGES 0
NET-INCOME (14,589)
EPS-PRIMARY (3.90)
EPS-DILUTED (3.90)
/TABLE
274
COVER
SEC Cover Letter
Wright Medical Technology Inc.
5677 Airline Road
Arlington, TN 38002
March 25, 1997
Securities and Exchange Commission
450 5th Street, N.W.
Judiciary Plaza
Washington, D.C. 20549
Dear Sirs:
Pursuant to regulations of the Securities and Exchange
Commission, submitted herewith for filing on behalf of Wright
Medical Technology, Inc., (the "Company") is the Company's annual
Form 10-K for the year ended December 31, 1996.
This filing is being effected by direct transmission to the
Commission's EDGAR System.
Sincerely,
RICHARD D. NIKOLAEV
President and Chief Executive Officer