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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1996
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 000-19168
SOFAMOR DANEK GROUP, INC.
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Indiana 35-1580052
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(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1800 Pyramid Place, Memphis, Tennessee 38132
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (901) 396-2695
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Common Stock, no par value New York Stock Exchange
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SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
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(TITLE OF CLASS)
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Indicate by check mark whether 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
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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 of this
Form 10-K. [ ]
At February 28, 1997, based on the closing sales price of the Common Stock,
as reported on the New York Stock Exchange, the aggregate market value of the
voting stock held by non-affiliates of the registrant was approximately
$753,605,368.
At February 28, 1997, there were 24,564,306 shares of registrant's common
stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement relating to its
1997 Annual Meeting of Shareholders are incorporated by reference in Part III of
this Form 10-K. Certain exhibits to registrant's Form S-1 Registration Statement
No. 33-39593, registrant's Annual Report on Form 10-K for the fiscal years ended
December 31, 1991, 1992, 1993, 1994 and 1995 and registrant's Form S-4
Registration Statement No. 33-63040 are incorporated by reference in Part IV of
this Form 10-K.
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TABLE OF CONTENTS
AND
CROSS REFERENCE SHEET
PAGE NUMBER
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PART I Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Use of Spinal Implants . . . . . . . . . . . . . . . . . . . . . . 2
Principal Products . . . . . . . . . . . . . . . . . . . . . . . . 2
Marketing and Distribution . . . . . . . . . . . . . . . . . . . . 4
Manufacturing and Quality Control . . . . . . . . . . . . . . . . 4
Research and Product Development . . . . . . . . . . . . . . . . . 5
New Product Opportunities . . . . . . . . . . . . . . . . . . . . 5
Government Regulations . . . . . . . . . . . . . . . . . . . . . . 6
Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Patents, Trademarks and Copyrights . . . . . . . . . . . . . . . . 8
Royalty and Other Payments . . . . . . . . . . . . . . . . . . . . 9
Raw Materials . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Principal Customers . . . . . . . . . . . . . . . . . . . . . . . 9
Environmental . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . 13
Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . 13
PART II Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . 15
Item 6. Selected Consolidated Financial Data . . . . . . . . . . . . . . . . 16
Item 7. Management's Discussion and Analysis of Results of
Operations and Financial Condition . . . . . . . . . . . . . . . . 17
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . . . . 24
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure . . . . . . . . . . . . . . . 45
PART III Item 10. Directors and Executive Officers of the Registrant . . . . . . . . . 45
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . 45
Item 12. Security Ownership of Certain Beneficial Owners
and Management . . . . . . . . . . . . . . . . . . . . . . . . . . 45
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . 46
PART IV Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
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PART I
ITEM 1. BUSINESS.
OVERVIEW*
Sofamor Danek Group, Inc. is primarily engaged in the development, manufacturing
and marketing of spinal implant devices which are used in the surgical treatment
of spinal conditions such as degenerative diseases, deformities and trauma. The
objective of spinal implants is to facilitate fusion of elements of the spine.
Demand for the Company's products is affected by both the number of spinal
fusions performed and the percentage of these operations which utilize spinal
implants.
The Company is an Indiana corporation formed in 1983. The Company changed its
name from Biotechnology, Inc. to Danek Group, Inc. in August 1990, and from
Danek Group, Inc. to Sofamor Danek Group, Inc. in June 1993. Sofamor Danek
Group, Inc.'s principal offices are located at 1800 Pyramid Place, Memphis,
Tennessee 38132, and its telephone number is (901) 396-2695. As used in this
Report, unless the context indicates otherwise, Sofamor Danek Group, Inc. and
its subsidiaries are collectively referred to as the "Company" and, unless
otherwise indicated, all subsidiaries are wholly owned. "Sofamor" and "Danek"
are trademarks of the Company.
The executive offices, administrative offices and U.S. distribution facility of
the Company are located in Memphis, Tennessee, and its U.S. manufacturing
operations are conducted near Warsaw, Indiana, Broomfield, Colorado, West Palm
Beach, Florida and Las Vegas, Nevada. The Company also has a major manufacturing
and distribution facility in Rang-du- Fliers, France and distributes its
products primarily through its subsidiaries in France, Germany, Spain, Italy,
Hong Kong, Japan, the Benelux region, Australia, Korea, Puerto Rico and Canada.
The Company's principal products include the TSRH(R) Spinal System, the
Cotrel-Dubousset line of products and the ORION(TM) Anterior Cervical Plate
System (the "ORION System"). The TSRH components are part of a specialized
system of support rods and locking bolts which the Company believes allows for
increased torsional and axial spinal support. The Cotrel-Dubousset ("CD") line
of products include the CD(TM) Spinal Instrumentation System ( the "CD System"),
Compact CD System (the "CCD(TM) System") and the CD HORIZON(TM) Spinal System
(the "CD HORIZON System"). The CD System includes spinal rods, hooks, and
transverse traction devices which lock implants together and is principally used
to treat conditions of the spine in the thoracic and lumbar regions. The CCD
System is principally for ease of use by the surgeon when treating spinal
conditions of the lumbar and sacral spine and incorporates many of the same type
of components found in the CD System. The CD HORIZON System combines new types
of hooks and screws with components of several other systems to treat various
spinal conditions. The ORION System consists of plate and screws and is used to
treat conditions of the anterior cervical spine. Additional new products are now
under development. (See "Business-- New Product Opportunities.")
The Company expanded its product line in 1996 with the acquisition of MedNext,
Inc., Surgical Navigation Technologies, Inc. and certain net assets of TiMesh
Inc. MedNext's product line consists of a high-speed pneumatic drill, accessory
equipment and disposable burs for surgical specialties. Surgical Navigation's
product line consists
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* Except for the historical information contained in this Annual Report on Form
10-K, the matters discussed herein, including (without limitation) those
discussed in "New Product Opportunities," "Government Regulations," "Insurance,"
"Legal Proceedings" and "Management's Discussion and Analysis of Results of
Operations and Financial Condition", are forward-looking statements that involve
risks and uncertainties, including (without limitation) the timely development
and acceptance of new products, the impact of competitive products, the timely
receipt of regulatory clearances required for new products, the regulation of
the Company's products generally, the disposition of certain litigation
involving the Company and the other risks and uncertainties detailed from time
to time in the Company's periodic reports filed with the Securities and Exchange
Commission. For information regarding potential factors that could affect the
Company's operating results and financial condition see "Factors That May Affect
Future Operating Results and Financial Condition" contained in Part II, Item 7,
"Management's Discussion and Analysis of Results of Operations and Financial
Condition" of this Annual Report on Form 10-K. The description of products or
proposed products and technologies in this Annual Report on Form 10-K is not
intended nor should be construed as labeling for the Company's products. Readers
should not rely on this document for decisions to purchase, indications in use,
and/or instructions in use, and should see, read and follow all package inserts
accompanying the Company's products.
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of frameless stereotactic surgical products relating to the spinal and
neurological fields. The Timesh product line includes titanium plates and alloy
screws used to treat conditions in the cranial (head and facial) region.
The Company's strategy is to continue its focus on product development and
marketing to its worldwide customer base. The Company markets its products in
the U.S. to spinal surgeons through its network of approximately 180 independent
commissioned sales representatives. Prior to July 1, 1994, the CD System and CCD
System were sold in the U.S. by an independent third-party distributor. (See
Item 7, "Management's Discussion and Analysis of Results of Operations and
Financial Condition--Overview"). The Company markets its products
internationally to spinal surgeons in approximately 65 countries primarily
through a network of independent distributors and agents. In France, Germany,
Spain, Italy, Hong Kong, Japan, the Benelux region, Australia, Korea, Puerto
Rico and Canada, the Company's subsidiaries distribute products.
USE OF SPINAL IMPLANTS
Spinal fusions are performed to treat diseases and conditions such as the
following:
DEGENERATIVE DISEASES. Typically occurring in mature adults,
degenerative diseases of the spine can result in immobility, pinched
nerves and associated pain for the patient.
DEFORMITIES. Deformities, unless treated at a young age, can prevent
proper growth of the spine and can be life threatening if allowed to
progress. Spinal implants straighten the spine to allow for proper
alignment of internal organs.
TRAUMA. The typical cause of traumatic spinal conditions is automobile
accidents.
Spinal implants are used to facilitate the fusion of two or more vertebrae in
the spine. The potential benefit of a spinal implant is increased spinal
stability in order to facilitate fusion of the vertebrae. A surgeon's decision
to treat a spinal condition with an implant is based on many factors. The
relative severity of the patient's condition, such as the degree of the
curvature of the spine, is assessed against the potential risks and benefits of
the spinal operation. The age of the patient, the patient's medical history and
the physical condition of the patient (i.e., the ability to withstand surgery)
are all important considerations in deciding which treatment path to implement.
Until the mid-1980's, surgeons had limited implant options for treating spinal
conditions. Surgeons treating spinal conditions either did so without implants
or utilized basic implant devices. These devices often did not, however,
sufficiently immobilize the spine, and thus limited the fusion rate and efficacy
of the procedures. In seeking better alternatives for spinal fusions, surgeons
began to use implants designed primarily to provide greater structural support
for the spine, which would enhance the healing process. Over the last several
years, clinical studies have shown that surgeries using spinal implants are more
effective in immobilizing the spine than surgeries in which implants are not
used.
PRINCIPAL PRODUCTS
TSRH(R) SPINAL SYSTEM.
The TSRH Spinal System traces its origins to research conducted at the Texas
Scottish Rite Hospital in Dallas, Texas and is used primarily to treat patients
afflicted with scoliosis or deformities of the spine. The Company manufactures
and distributes the TSRH Spinal System under agreements pursuant to which the
Company has received the exclusive worldwide rights to the products in exchange
for an agreement to pay a percentage of net sales of the products. Sales of the
TSRH Spinal System accounted for 33% of the Company's consolidated sales in
1996, 38% in 1995 and 43% in 1994. "TSRH" is a trademark of the Company.
In 1989, the Company introduced the TSRH Spinal System at the American Academy
of Orthopaedic Surgeons' annual meeting and began shipments of the product. The
system consists of specialized hooks, plates and screws that are attached to
rods through locking bolts. There are special configurations of the system
available to address
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specific applications such as pediatric surgery and adult lumbar surgery. This
system is marketed in the U.S. as a spinal device system. (See
"Business--Government Regulations.")
The Company has added enhancements to the TSRH Spinal System, including the
Variable Angle Screw, Central Post Hook, Lateral Offset Plate, Open Eyebolt, and
Top Tightening components. The Variable Angle Screw provides flexibility in
screw placement in relation to the spinal rod. Similarly, the Central Post Hook
offers versatility in hook placement. The Lateral Offset Plate allows variations
in the lateral distance between a hook or sacral screw and the spinal rod. The
Open Eyebolt can be used when an eyebolt must be added after all hooks and
CROSSLINK(R) plates are in place. The Top Tightening components incorporate
T-bolts, hooks, sacral/iliac screws, and staples into a comprehensive spinal
implant system. These enhancements provide interchangeability of components and
improved ease of use for surgeons. The TSRH Spinal System is covered by various
patents.
COTREL-DUBOUSSET LINE OF PRODUCTS.
The Cotrel-Dubousset line of products traces its origin to the development of
the CD System by Dr. Yves Paul Cotrel in cooperation with Sofamor, S.N.C.
("Sofamor"), a subsidiary of the Company, and with the assistance of Professor
Jean Dubousset. Sales of the Cotrel-Dubousset line of products accounted for 23%
of the Company's consolidated sales in 1996, 26% in 1995 and 30% in 1994.
COTREL-DUBOUSSET SPINAL INSTRUMENTATION SYSTEM. The CD System was
introduced in 1984 following years of development by Dr. Yves Paul
Cotrel in cooperation with Sofamor and with the assistance of Professor
Jean Dubousset. The CD System was designed primarily to treat patients
afflicted with spinal deformities and fractures of the spine in the
thoracic and lumbar regions. The principal components of the CD System
include spinal rods, hooks, sacral screws and transverse traction
devices which lock implants together and a wide range of instruments
used to position and secure the implants.
COMPACT COTREL-DUBOUSSET SYSTEM. In response to the growing utilization
of spinal instrumentation in the treatment of degenerative diseases,
Sofamor developed the CCD System. The CCD System was designed
principally for the treatment of degenerative spinal conditions of the
lumbar and sacral spine.
CD HORIZON(TM) SPINAL SYSTEM. The CD HORIZON System combines new types
of hooks and screws with components of several other systems for the
treatment of various spinal conditions.
Each of the CD, CCD and CD HORIZON Systems is marketed in the U.S. as a spinal
device system and is covered by various patents; "CD," "CCD" and "CD HORIZON"
are trademarks of the Company. (See "Business--Government Regulations.)
ORION(TM) ANTERIOR CERVICAL PLATE SYSTEM. The ORION Anterior Cervical Plate
System was introduced in 1994 following development in 1992 by the Company with
the assistance of Gary L. Lowery, M.D., Ph.D. This system is indicated for use
in stabilizing the anterior cervical spine during the development of a solid
spinal fusion in patients with degenerative diseases, traumatic fractures, and
tumors. The system consists of a plate and screws which attach to the anterior
cervical spine (front part of the neck). The Company manufactures and
distributes the ORION System under agreements pursuant to which the Company
obtained the exclusive worldwide rights to the products in exchange for an
agreement to pay a percentage of the net sales of the products. This system is
marketed in the U.S. as a spinal device system. (See "Business--Government
Regulations.") The ORION Anterior Cervical Plate System accounted for 10% of the
Company's consolidated sales in 1996, 8% in 1995 and 3% in 1994. The system is
covered by various patents; "ORION" is a trademark of the Company.
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MARKETING AND DISTRIBUTION
The Company's products currently are used in hospitals and clinics throughout
the U.S. These hospitals and clinics (and their surgeons) are served by a
network of approximately 180 independent commissioned sales representatives.
Prior to July 1, 1994, the CD System and CCD System were sold in the U.S. by an
independent third-party distributor. (See Item 7, "Management's Discussion and
Analysis of Results of Operations and Financial Condition--Overview.") The
Company's direct marketing and distribution activities in the U.S. are performed
primarily from Memphis, Tennessee through Danek Medical, Inc. ("Danek Medical"),
a subsidiary that the Company acquired in 1985. Danek Sales Corporation, a
subsidiary of the Company, provides marketing support in the U.S. In meeting the
needs of hospitals and clinics, the Company offers various instrument and
implant purchase alternatives. For example, one implant purchase alternative is
often referred to as a "loaner program" whereby a complete implant system is
shipped overnight for next-day surgery. The customer is charged only for the
components used, and a premium over the published list price is charged to
defray the additional cost of the program.
Internationally, the Company distributes its products primarily through Company
subsidiaries in France, Germany, Italy, Spain, Hong Kong, Japan, the Benelux
region, Australia, Korea, Puerto Rico and Canada. Sofamor is responsible for the
marketing and distribution of the Company's products in France. In Germany,
Sofamor Danek GmbH ("Sofamor Germany"), a subsidiary, directly sells the
Company's products. Sofamor Danek Asia Pacific Ltd., a subsidiary, is
responsible for marketing support and direct selling in Hong Kong and China. The
Company also has subsidiaries in Milan, Italy (Sofamor Danek Italia S.r.l.) and
in Madrid, Spain (Sofamor Danek Iberica S.A.), each of which is responsible for
selling to customers directly and, in the case of Sofamor Danek Italia, S.r.l.,
to regional distributors as well. Sofamor Danek Benelux, a majority-owned sales
and distribution subsidiary, markets products in Belgium, The Netherlands and
Luxembourg. The Company's subsidiary in Japan, Kobayashi Sofamor Danek K.K., is
co-owned by the Company and Kobayashi Pharmaceutical Co., Ltd., the Company's
distributor in Japan; however, the Company controls the financial and
operational direction of the subsidiary. The Company sells the products it
manufactures to its subsidiary, Kobayashi Sofamor Danek K.K., which, in turn,
resells the product in Japan at near retail prices through Kobayashi
Pharmaceutical's distribution network. The Company's subsidiary in Korea, Danek
Korea Co., Ltd., is co-owned by the Company and Joint Medical Company, the
Company's distributor in Korea; however, the Company controls the financial and
operational direction of the subsidiary. The Company sells the products it
manufactures to its subsidiary, Danek Korea Co., Ltd., which, in turn, resells
the products in Korea at near retail prices through Joint Medical Company's
distribution network. The Company also has subsidiaries in Australia (Sofamor
Danek Australia Pty. Ltd.), Canada (Sofamor Danek Canada, Inc.) and Puerto Rico
(Sofamor Danek Puerto Rico, Inc.), each of which is responsible for selling to
customers directly or, in certain cases, to regional distributors in their
respective countries. Products are distributed to other countries through
independent distributors and agents. The independent distributors have
contractual distribution rights to geographical territories in which they have
established organizations.
International sales have amounted to $82,298,000 and $62,474,000, representing
approximately 34% and 33% of total sales in 1996 and 1995, respectively.
The Company's backlog of firm orders is not considered material to an
understanding of its business.
MANUFACTURING AND QUALITY CONTROL
The Company's products are manufactured in the U.S. primarily by the Company's
subsidiary, Warsaw Orthopedic, Inc. ("Warsaw Orthopedic"), which the Company
acquired in 1983. Warsaw Orthopedic is located near Warsaw, Indiana. The
Company's products are also manufactured by its subsidiaries, Surgical
Navigation Technologies, Inc., located in Broomfield, Colorado, MedNext, Inc. of
West Palm Beach, Florida and Sofamor Danek Nevada, Inc., which is located in Las
Vegas, Nevada. As a medical device manufacturer, the Company is subject to
stringent "good manufacturing practices" and regulations as stipulated by the
Food and Drug Administration ("FDA"). (See "Business--Government Regulations.")
The Company has installed computer controlled machinery in its manufacturing
operations, resulting in greater flexibility in the manufacturing process and
enabling the Company to be cost efficient. The Company also utilizes
comprehensive, integrated MIS (management information system)
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software for production, planning and scheduling. The Company employs a broad
range of inspection and quality assurance standards. The Company utilizes
in-process testing and inspection methods in the manufacturing process to
produce quality products. The design and layout of the Company's manufacturing
facilities affords the Company flexibility to increase production capacity.
Outside the U.S., product manufacturing is done primarily by Sofamor, located in
Rang-du- Fliers, France. Some of the manufacturing outside the U.S. is performed
by subcontractors. Sofamor has a 33.75% equity investment in one of the
subcontractors.
RESEARCH AND PRODUCT DEVELOPMENT
The Company's U.S. and European research and product development activities are
carried on by Danek Medical in Memphis, Tennessee, MedNext, Inc. in West Palm
Beach, Florida, Sofamor Danek Nevada, Inc. in Las Vegas, Nevada, Surgical
Navigation Technologies, Inc. in Broomfield, Colorado and by Sofamor in its
Paris, France office. These departments, with over 60 engineers, have
significant experience in biomedical product design and are divided into
functional groups, focusing on key product groups. The Company has continued to
expand its CAD/CAM (computer assisted design/computer assisted manufacturing)
capabilities internationally, as well as its functional testing programs. The
Company has also expanded its activities in the area of clinical trials and the
manufacturing of special order implants for products used outside the U.S.
In addition, the Company has continued to integrate projects among all its
development groups in order to leverage its resources while enhancing its time
to market on a global basis. The Company incurred research and development
expenses of approximately $15,926,000, $13,980,000 and $11,572,000 for the years
ended December 31, 1996, 1995 and 1994, respectively.
NEW PRODUCT OPPORTUNITIES
The following new products are currently either under development or are being
considered by the Company for possible future development.
BIOLOGICAL PRODUCTS FOR USE IN SPINAL RECONSTRUCTION.
In February 1995, the Company entered into a strategic alliance with Genetics
Institute, Inc. ("Genetics Institute") to provide biological products for use in
spinal applications. The products will use Genetics Institute's recombinant
human bone morphogenetic protein (rhBMP-2) to induce bone growth necessary for
the treatment of spinal disorders. The Company has obtained exclusive North
American rights to these rhBMP-2 proprietary technologies and patents for spinal
applications. Pursuant to the terms of the agreement, the Company will pay
Genetics Institute $50 million over four years, of which $12.5 million was paid
in each of 1995 and 1996. FDA review and approval, which will require the
conduct of clinical trials, will also be necessary to market these biological
products. The Company will purchase the rhBMP-2 product from Genetics Institute.
The Company is considering a variety of different carriers for the Genetics
Institute proteins. One potential carrier is a porous polymer to which the
Company has obtained worldwide rights under an exclusive license. If this porous
polymer carrier is utilized with rhBMP-2, royalty payments will be due to the
owner of the polymer technology.
SPINAL FUSION IMPLANTS, INSTRUMENTS AND METHOD TECHNOLOGIES.
In January 1994, the Company acquired various patented technologies for an
interbody fusion device used in the stabilization of the spine during a spinal
fusion and discectomy. The Company has also entered into a licensing agreement
for the worldwide rights to these patented technologies covering implants,
instruments and methodologies for simultaneously performing a discectomy, a
fusion and an internal stabilization of the spine. The Company sold the devices
covered by the patented technologies internationally during 1996 and, after FDA
authorization, will begin commercializing the devices in the U.S. The Company
pays a royalty based on a percentage of the net sales of the devices.
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OPEN PORE TANTALUM STRUCTURE MATERIAL.
In February 1995, the Company entered into an agreement with Implex Corporation
under which the Company obtained the exclusive worldwide rights to certain
patented proprietary material technologies for spinal applications. This
material is used in the manufacture of the Company's interbody fusion devices
for distribution outside the U.S. and, when authorized by the FDA, for U.S.
distribution.
PROSTHETIC DISC PROGRAM.
The Company is actively evaluating various designs for the replacement of
diseased and/or damaged discs. These designs are at various stages of
development and would ultimately require pre-market approval by the FDA prior to
marketing in the U.S.
There can be no assurances that the products described above in this section
will be marketed or that FDA authorization will be received. Spinal implants and
other related devices are typically rendered obsolete within a few years. While
the Company maintains active research and development programs, there can be no
assurance that it will be able to develop and introduce new products that will
enable it to remain competitive in the future. (See Item 7, "Management's
Discussion and Analysis of Results of Operations and Financial
Condition--Factors That May Affect Future Operating Results and Financial
Condition--Product Obsolescence.")
GOVERNMENT REGULATIONS
In the United States, the Company is subject to regulation by the FDA. FDA
regulations govern the labeling, promotion and sale of medical devices and
require the Company to maintain certain standards and practices with respect to
the manufacturing and labeling of devices, the maintenance of certain records
and medical device reporting. The Company's facilities and records are subject
to FDA inspections.
The FDA is the agency responsible for the regulation of medical devices in the
U.S. pursuant to the Food, Drug and Cosmetic Act (as amended by the 1976 Medical
Devices Amendment), the Safe Medical Devices Act of 1990 (as amended in 1992),
the regulations promulgated thereunder and guidance documents and instructions
issued by the FDA. In general, prior to entering commercial distribution,
medical devices must undergo FDA review, either pursuant to a Section 510(k)
notification or a Pre-Market Approval ("PMA") application filed by the
manufacturer of the device. A Section 510(k) notification is a filing submitted
to demonstrate that the device in question and its labeling are "substantially
equivalent" to "a legally marketed device" and its labeling. In contrast, a PMA
must demonstrate that the device is safe and effective; it is a more complex
submission that typically includes a two-year follow-up of a controlled human
clinical study. Factors that dictate whether a Section 510(k) notification or a
PMA is required include: whether the device and its labeling are "substantially
equivalent" to a "legally marketed device" and its labeling. The process of
obtaining marketing authorizations can be time consuming, and there can be no
assurance that all the necessary authorizations will be granted to the Company
with respect to new products and devices developed by the Company.
All of the Company's implants currently marketed in the U.S. are covered by
Section 510(k) notifications with limited exceptions, such as custom implants.
As devices become increasingly innovative, it is difficult to establish that a
device is "substantially equivalent" to another "legally marketed device" and
thereby obtain Section 510(k) clearance for a new product. Additionally, as
clarified by the Safe Medical Devices Act of 1990, the FDA could, and generally
does, decide to require the submission of additional data. It is impossible to
predict whether additional changes will be made in the Section 510(k) clearance
practices and whether any such changes could have an adverse effect on the
Company and its business. The Company cannot predict the extent or impact of
future federal, state or local legislation or regulation.
Federal law provides that manufacturers can label and promote new medical
devices only for indications that have been allowed by the FDA. The Company's
Section 510(k) clearances do not indicate use of any product for interpedicular
segmental fixation (use of screws in the pedicle, a bony support structure, of
the spine) other than for limited uses pursuant to Section 510(k) clearances
that the Company began receiving in January 1995 (discussed
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further below). Since the FDA does not regulate the practice of medicine,
physicians may use products for applications that have not yet been cleared by
the FDA for such a labeling indication if such use is deemed in their medical
judgment to be in the patient's best interests. Thus, as part of the practice of
medicine, physicians may at their discretion and in the exercise of their
medical judgment use any screws (or any other suitable products) for such
fixation. Although this practice may continue in the future, the Company does
not encourage nor can it predict such use.
In January 1995, the Company received Section 510(k) clearance to begin labeling
and marketing the stainless steel version of the TSRH Spinal System for pedicle
screw attachment only for treating selected patients with grade 3 or 4 severe
spondylolisthesis of the fifth lumbar - first sacral (L5-S1) vertebral joint.
The clearance is based on this spinal system having been found equivalent only
to similar device systems labeled and intended for patients: (a) who have severe
spondylolisthesis (grades 3 and 4) of the fifth lumbar - first sacral (L5-S1)
vertebral joint; (b) who are receiving fusions using autogenous bone graft only;
(c) who are having the device fixed or attached to the lumbar and sacral spine;
and (d) who are having the device removed after the development of a solid
fusion mass. This clearance requires the addition of specific warnings to the
labeling of the product. Since that time, many other systems offered by the
Company have received clearance for similar labeling.
In May 1990, the Director of the FDA's Division of Compliance Operations for the
Center for Devices and Radiological Health sent a letter to approximately 80
manufacturers and distributors of medical devices, including the Company, which
advised that companies must not label, or in any way promote, devices to be used
in the U.S. for pedicular screw attachment to, or fixation of, the vertebral
column. The Company examined all of its literature and voluntarily recalled one
brochure used to recruit clinical investigators. This recall was examined for
effectiveness by the FDA beginning in May 1991 and found to be complete in
February 1992. In August 1993, the Company and six other companies received
warning letters from the FDA, primarily regarding the issue of supporting
medical education programs where physicians "demonstrate" the use of screws in
the pedicle of the spine. The Company responded to the warning letter, and no
official response from the FDA has ever been received. In February 1995, the
Company received a warning letter from the FDA regarding the wording in a
Company press release and "Dear Doctor" letter relating to the January 1995
Section 510(k) clearance referred to above. The Company submitted a written
response to the FDA on March 17, 1995 and took certain actions in response to
the letter. The Company believes that it has taken all the appropriate actions
possible regarding this matter.
With respect to a different but related matter, in April and June 1994, many
orthopaedic companies received letters from the FDA stating that certain warning
statements must appear on all labeling of certain devices. The Company believes
it is complying with all labeling requirements for those devices in the U.S.
that need such warning statements.
The Company cannot, however, rule out the possibility that the FDA could bring a
regulatory action without further notice against the Company with respect to any
of the matters referred to above. Such regulatory action might include, but
would not be limited to, civil and/or criminal penalties, an injunction against
any distribution in the U.S., seizure, fines, and/or recall of any Company
product or labeling. The inability to continue to sell certain products could
have a material adverse impact on the Company's business and financial
condition.
The Company's products are also subject to regulation by foreign governmental
and regulatory authorities. The Company believes that it has all necessary
foreign authorizations where its products are sold. There can be no assurances
that foreign regulatory requirements will not become more stringent in the
future. In Europe, individual European Union ("EU") members have required
compliance and testing for some devices (e.g., electromedical devices), but in
most countries testing of implants has been voluntary.
A Medical Devices Directive (the "Directive") for the EU was adopted on June 14,
1993. Proof of compliance with the harmonized standards will be presumptive
proof of compliance with the legal requirements in each EU member country. If
compliance with the standards cannot be demonstrated or standards have not been
issued for the product in question, the manufacturer will have to supply an
application that proves the product is safe and effective. While there is
uncertainty as to the specific national enabling legislation, the Company does
not anticipate any special
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concerns uniquely applicable to the Company since this legislation affects all
medical device manufacturers and distributors. There can be no assurance that
new legislation will not cause delays or disruptions in the marketing of the
Company's products in Europe. In 1995, the Company's Memphis, Warsaw and French
facilities were ISO 9001 certified pursuant to the Directive. The Company
believes it is well positioned to compete in the European market when the
regulations take full effect in 1998.
All of the Company's products are prescription devices that are in the U.S. for
sale only by or on the order of a physician. Neither this document nor any other
communication to the financial community by the Company is intended or should be
construed as labeling for the Company's products. Any learned intermediary or
health care professional who reads this document or any other communication to
the financial community should not rely on this document for decisions to
purchase, indications in use and/or instructions in use. Instead, any health
care professionals who may read this or any other Company document should see,
read and follow all package inserts accompanying the Company's products. (See
Item 7, "Management's Discussion and Analysis of Results of Operations and
Financial Condition--Factors That May Affect Future Operating Results and
Financial Condition--Regulatory Approvals.")
COMPETITION
Worldwide, there are many firms producing spinal implant devices. Because of the
significant growth of the number of spinal fusion procedures performed in recent
years, a number of companies, including those producing various medical devices
and having financial, marketing and technical resources significantly greater
than those of the Company, have begun to market and sell spinal devices. The
Company anticipates that additional companies will also begin similar efforts.
The Company believes that it competes based on (i) the Company's participation,
through medical symposia and seminars, in the education of surgeons in the
cleared uses of implant products, (ii) the Company's emphasis on research and
development, (iii) the introduction of new products and systems, (iv) the
quality of the Company's products and their ease and versatility of use by
surgeons, (v) the Company's association with spinal surgeons and (vi) the
Company's focus on spinal products coupled with a solid infrastructure of
experienced management personnel. (See Item 7, "Management's Discussion and
Analysis of Results of Operations and Financial Condition-- Factors That May
Affect Future Operating Results and Financial Condition--Competition.")
EMPLOYEES
The Company had approximately 810 employees at December 31, 1996. No U.S.
employee of the Company is represented by a labor union or is subject to a
collective bargaining agreement. All of the employees outside the U.S. are
covered by applicable industry collective bargaining agreements as may be
required by government authorities in the respective countries where those
employees are located. The Company has never experienced a work stoppage due to
labor difficulties.
PATENTS, TRADEMARKS AND COPYRIGHTS
As of December 31, 1996, the Company owned or held licenses to 154 inventions
covered by 232 patents and had 451 applications pending on 121 more inventions
covering the full spectrum of its product lines in the U.S. and major countries
throughout the world. In addition, the Company has acquired rights under various
purchase, license or distribution agreements related to the design, manufacture
and distribution of certain products and devices. (See "Business--Principal
Products.") The Company has 38 registered trademarks and applications pending
for registration on 36 other marks in the U.S. and other major countries
throughout the world. The Company currently has six registered copyrights for
certain of its product manuals and two other applications pending. (See Item 7,
"Management's Discussion and Analysis of Results of Operations and Financial
Condition--Factors That May Affect Future Operating Results and Financial
Condition--Intellectual Property.")
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ROYALTY AND OTHER PAYMENTS
The Company has agreements with certain unaffiliated entities which provide the
Company with the rights to manufacture and market certain spinal system products
developed by these entities. These agreements provide for payments ranging from
1% to 10% of the net selling prices (as defined by the agreements) of all
products sold. These agreements are in force as long as the Company sells these
products.
Royalty expenses and licensing fees made pursuant to the agreements referred to
above during fiscal years 1996, 1995 and 1994 were approximately $6,768,000,
$5,907,000 and $4,083,000, respectively.
RAW MATERIALS
Implant grade stainless steel and titanium alloy account for the majority of the
Company's raw material purchases. There are multiple sources from which the
Company may purchase this type of stainless steel and titanium alloy, and it is
available within one to eight months of the time an order is placed. Titanium
alloy provides less MRI (magnetic resonance image) interference during imaging
of the patient during postoperative follow-up.
PRINCIPAL CUSTOMERS
The Company does not rely on any single hospital or clinic for a material
portion of its business. The Company has over 4,000 hospital and clinic
customers, none of which accounts for more than 2% of sales. Prior to July 1,
1994, the CD System and CCD System were distributed in the U.S. through an
exclusive agreement with National Medical Specialty, Inc. ("NMS"). This customer
accounted for 5% and 16% of the Company's total sales in 1994 and 1993,
respectively.
In 1996, the Company formed a new subsidiary in Japan which is a joint venture
co-owned by the Company and Kobayashi Pharmaceutical Co., Ltd., the Company's
former distributor in Japan. This distributor accounted for 10%, 8% and 6% of
the Company's total sales in 1996, 1995 and 1994, respectively. The Company
sells the products it manufactures to its subsidiary, which, in turn, resells
the products in Japan at near retail prices through Kobayashi Pharmaceutical's
distribution network.
For information relating to the amounts of revenue, operating profit or loss and
identifiable assets attributable to each of the Company's geographic areas, see
"Notes to Consolidated Financial Statements--Foreign Operations."
ENVIRONMENTAL
The Company believes it is in compliance in all material respects with all
applicable environmental regulations and does not expect to require a material
amount of capital expenditures in order to remain in compliance.
INSURANCE
The Company carries comprehensive and general liability insurance, as well as
coverage for product liability. The Company also carries liability insurance
coverage for directors and officers. Such directors' and officers' policy
contains certain exclusions, including, but not limited to, certain claims by
stockholders. (See Item 3, "Legal Proceedings" and Item 7, "Management's
Discussion and Analysis of Results of Operations and Financial Condition-Factors
That May Affect Future Operating Results and Financial Condition--Product
Liability; Insurance.")
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ITEM 2. PROPERTIES.
The Company's headquarters and primary U.S. distribution facility are located in
Memphis, Tennessee. The Company utilizes a 60,000 square foot owned facility and
9,730 square feet of lease space for these functions. The Company is in need of
additional office and distribution space at its Memphis location. The Company is
currently considering the alternatives of constructing or leasing a new
facility. The primary U.S. manufacturing operations for the Company are
conducted in an 83,000 square foot plant located near Warsaw, Indiana, under a
lease which expires December 31, 1999, with four one-year extensions available
thereafter. Approximately 33,000 square feet of the Warsaw facility are
currently not used by the Company. Management believes that the Company's Warsaw
facility is suitable for its current use and adequate for the Company's
operation for the foreseeable future. The Rang-du-Fliers, France location
utilizes a 57,500 square foot facility situated on 10.8 acres of land owned by
Sofamor, which also has approximately 16,000 square feet of leased office space
in Paris used for marketing, sales, development and administrative activities.
Subsidiaries of the Company have leased office space in Milan, Italy, Cologne,
Germany, Epping, NSW, Australia, Seoul, Korea, San Juan, Puerto Rico,
Mississauga, Canada, Saint Genis Laval, France, Hong Kong, Madrid, Spain, Tokyo
and Osaka, Japan, Luxembourg City, Luxembourg, Broomfield, Colorado, Las Vegas,
Nevada, and West Palm Beach, Florida.
ITEM 3. LEGAL PROCEEDINGS.
The Company is involved from time to time in litigation on various matters which
are routine to the conduct of this business, including product liability and
intellectual property cases.
PRODUCT LIABILITY CASES
Multidistrict Litigation:
In 1994, the Company and other spinal implant manufacturers were named as
defendants in purported class action product liability lawsuits in various
federal courts throughout the country alleging that plaintiffs were injured by
spinal implants manufactured by the Company and others. On August 4, 1994, the
Federal Judicial Panel on Multidistrict Litigation ordered that all federal
court lawsuits then existing be transferred to and consolidated for pretrial
proceedings, including the determination of class certification, in the United
States District Court for the Eastern District of Pennsylvania in Philadelphia
(the "Multidistrict Litigation"). Federal court lawsuits filed after August 4,
1994 have also been transferred to and consolidated in the Eastern District of
Pennsylvania. On February 22, 1995, Chief Judge Emeritus Louis C. Bechtle denied
class certification. The federal court lawsuits before Judge Bechtle will remain
coordinated for further pretrial purposes but are individual lawsuits. As
previously disclosed, as a result of the denial of class certification by Judge
Bechtle, a large number of additional plaintiffs have filed lawsuits alleging
injuries caused by spinal implants manufactured by the Company. To date,
approximately two thousand eight hundred (2,800) plaintiffs have filed lawsuits
against the Company, with a few also naming as defendants various officers and
directors of the Company. A majority of these plaintiffs filed their claims in
1995. Also, plaintiffs' lawyers have filed lawsuits involving about two thousand
eight hundred fifty (2,850) claimants alleging a conspiracy theory among
doctors, manufacturers (including the Company), hospitals, teaching
institutions, professional societies and others to promote, in violation of
applicable law, the use of spinal implants. Some plaintiffs have filed
individual lawsuits, whereas other lawsuits list multiple plaintiffs and, in
certain instances, multiple lawsuits have been filed on behalf of the same
individual plaintiffs. On August 22, 1996, Judge Bechtle dismissed without
prejudice plaintiffs' conspiracy claims. Many plaintiffs asserting these
conspiracy claims have filed amended or new complaints, but it is not possible
at this time to determine precisely how many of these conspiracy complaints will
be reasserted or the number of additional plaintiffs that may file lawsuits.
The majority of such lawsuits were filed in federal courts throughout the
country and are in the preliminary stages. Discovery proceedings, including the
taking of depositions, have been ongoing in certain of the lawsuits that were
first to be filed. Discovery in certain cases that were filed later will begin
in 1997. Over one thousand eight hundred (1,800) of the plaintiffs have had
their lawsuits returned to the state court in Memphis, Tennessee because it was
determined that the federal courts lacked jurisdiction over their claims. It is
anticipated that the Memphis, Tennessee state court judge will establish a
schedule for case management and discovery. The trials of a number of
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lawsuits involving individual plaintiffs are scheduled to begin in the first six
months of 1997, although delays in trial dates are common. Although plaintiffs
have advanced claims under many different legal theories, the essence of
plaintiffs' claims appears to be that the Company (including Sofamor and its
former U.S. distributor) marketed some of its spinal systems for pedicle
fixation in contravention of FDA rules and regulations (governing marketing and
labeling), that pedicle fixation has not been proven safe and efficacious in the
context of FDA labeling standards and that plaintiffs have suffered a variety of
injuries as a result of the use of the systems for pedicle fixation. Plaintiffs
in these cases typically seek relief in the form of monetary damages, often in
unspecified amounts. Many of the plaintiffs only allege as monetary damages an
amount in excess of the jurisdictional minimum for the courts in which such
cases are filed.
In December 1996, AcroMed Corporation ("AcroMed"), a spinal implant manufacturer
and a defendant in various of the cases pending in the Multidistrict Litigation,
and the Plaintiffs' Legal Committee in the Multidistrict Litigation announced
that they have entered into an understanding to resolve all product liability
claims involving the use of AcroMed devices to achieve pedicular fixation in
spinal fusion surgery. Under the announced terms of the proposed settlement,
AcroMed will establish a settlement fund consisting of $100 million in cash and
the proceeds of its product liability insurance policies. The parties submitted
in January 1997 a formal class settlement agreement and related documentation
for approval by Judge Bechtle. A hearing (scheduled for April 23, 1997) will be
held to consider the fairness, adequacy and reasonableness of the settlement.
All federal court proceedings involving AcroMed devices have been stayed pending
final consideration of the proposed settlement.
Tennessee and Oregon Product Liability Actions:
In January 1995, the Company and other spinal implant manufacturers, doctors and
a hospital were named defendants in a purported class action product liability
lawsuit filed in Nashville, Tennessee state court. This lawsuit is limited to
those individuals whose surgeries were performed at one specific hospital. Class
certification has been denied by the trial judge in Nashville. The judge has
selected two of the Company's cases as test cases to be prepared for trial. Fact
discovery in these cases is scheduled for completion by March 1997. All other
proceedings are stayed. In October 1995, the Company was served with a Portland,
Oregon state court complaint that purported to be a class action. This Oregon
complaint alleged, among other things, injury based upon various legal theories.
In March 1996, the plaintiffs in this Oregon case withdrew the class
allegations. Discovery has begun in these individual cases. In these Tennessee
and Oregon actions, plaintiffs, who seek relief in the form of monetary damages
of unspecified amounts, are continuing their lawsuits as individual cases.
The Company believes that it has defenses, including, without limitation,
defenses based upon the failure of a cause of action to exist where no
malfunction of the implant has occurred or the plaintiff has suffered no injury
attributable to the Company's product, the expiration of the applicable statute
of limitations and the learned intermediary defense. The Company has and will
continue to assert the defenses primarily through the filing of dispositive
motions. The Company believes that all product liability lawsuits currently
pending against it are without merit and will continue to defend them
vigorously.
All pending cases are currently being defended by insurance carriers, generally
under reservation of rights. To date the cost of defending against claims has
been largely reimbursed by the Company's insurers. The Company's insurance
policies are reduced by the costs of defense, except for a policy issued by
Royal Surplus Lines Insurance Co. ("Royal") covering the 12-month period that
began in November 1995 (see below). The Company estimates that the litigation
may continue for several years and, if so, the cost to defend and conclude these
lawsuits is likely to exhaust its insurance coverage. An insurer, Royal,
providing coverage for the 12-month period commencing in November 1995, brought
an action in early December 1996 in the Federal District Court for the Middle
District of Tennessee (Nashville Division) seeking a declaratory judgment as to,
among other things, whether the policy covers lawsuits which have been reported
to the insurer during the policy period. At December 31, 1996, the Company had a
receivable from Royal of approximately $2.5 million for legal fees associated
with the Company's product liability litigation paid by the Company during the
policy year. The Company believes that the receivable is recoverable under the
terms of the policy. The case is in a preliminary stage. Discovery has just been
initiated. The Company believes the suit is without merit and will defend it
vigorously.
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As is common in the insurance industry, the Company's insurance policies
covering product liability claims must be renewed annually. Although the Company
has been able to obtain insurance coverage relating to product liability claims
at a cost and on other terms and conditions that are acceptable to the Company,
there can be no assurance that in the future it will be able to do so.
On January 6, 1997, the Company announced that its 1996 financial results would
include a pre-tax charge of $50 million relating to costs associated with the
product liability litigation described above. The charge, which has now been
reflected in the Company's 1996 financial statements, covers the reasonably
foreseeable costs that the Company was positioned in late December to estimate
because the litigation had progressed and because changes in the fourth quarter
of 1996 had occurred in facts and circumstances relating to the litigation.
Among the changed facts and circumstances were the announcement of the AcroMed
proposed settlement described above, the additional financial resources
available to the plaintiffs' attorneys as a result of the settlement if the
proposed settlement is ultimately approved, the likelihood that the litigation
will continue for several years, in part, due to the additional financial
resources provided to plaintiffs' attorneys if the proposed settlement is
approved, the absence of AcroMed as a member of the joint defense group, the
status of the Company's insurance described above and the continuing absence of
dispositive rulings relating to the Company's defense motions.
While it is not possible to accurately predict the outcome of litigation, the
amount of the charge taken in the fourth quarter represents the Company's best
judgment of the probable reasonable costs (in excess of available insurance) to
defend and conclude the lawsuits based on the facts and circumstances currently
existing. The costs provided for include, but are not limited to, legal fees
paid or anticipated to be paid and other costs related to the Company's defense
and conclusion of these matters.
The actual costs to the Company could differ from the estimated charge and will
be dependent upon a number of factors that will not be known for some time,
including, among other things, the resolution of defense motions and the extent
of further discovery. Although an adverse resolution of the lawsuits could have
a material effect on the Company's results of operations in future periods, the
Company does not believe that these matters will in the future have a material
adverse effect on its consolidated financial position. The Company is unable to
predict the ultimate outcome or the financial impact of the product liability
litigation.
SECURITIES LAWS ACTIONS
Beginning in April 1994, the Company and four of its officers and directors were
named in five shareholder lawsuits filed in the United States District Court in
Memphis, Tennessee. Four of the lawsuits purport to be class actions. All of the
lawsuits were consolidated into one case in the United States District Court in
Memphis through an amended complaint which added four new individual defendants
who are either current or former directors of the Company. The lawsuit alleges
that the defendants made false and misleading statements and failed to disclose
material facts to the investing public and seeks money damages. The alleged
securities law violations are based on the claim that the defendants failed to
disclose that the Company sold its products illicitly, illegitimately and
improperly and to timely disclose facts concerning the termination of the former
United States distributor of Sofamor products, National Medical Specialties,
Inc. ("NMS"). The allegations relating to illicit and illegitimate sales of
product are, for the most part, copied from product liability complaints filed
against the Company and other manufacturers currently being coordinated in the
United States District Court for the Eastern District of Pennsylvania which are
referred to above. The allegations of improper sales relate to one of the
Company's selling programs which has been publicly disclosed since May 1991. The
allegations concerning NMS relate to the termination of the NMS distribution
agreement covering Sofamor products in the United States. On October 3, 1995,
the United States District Court Judge in Memphis dismissed with prejudice the
entire case against the Company and each of the individual defendants. The
plaintiffs have appealed the dismissal to the United States Court of Appeals for
the Sixth Circuit, which has not yet ruled on this appeal.
SPANISH DISTRIBUTOR ACTION
In late September 1994, a Magistrate of the Commercial Court in Paris ruled in
favor of a former Spanish distributor of Sofamor's products on a claim of
wrongful termination of the distribution agreement in 1992. Prior to the
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Combination, an accrual was established, with a related charge to earnings, for
this pending litigation. On the Combination date in June 1993, the Company also
established a separate indemnity with respect to potential losses resulting from
such lawsuit and placed in escrow shares issued to the former Sofamor
shareholders pending the final outcome of this lawsuit. The $3.0 million award
(including interest) rendered by the French Magistrate exceeded the
pre-established accrual. As a result, the Company recorded an expense of $2.2
million for the non-recurring litigation award during the third and fourth
quarters of 1994. The Company filed an appeal which involves a complete retrial
on all issues. The former Spanish distributor recently filed its papers in the
appeal and seeks additional damages; the Company seeks to have the decision of
the Commercial Court reversed. A hearing on the appeal is currently scheduled
for the fourth quarter of 1997.
The Company does not believe the Securities Laws Actions or the Spanish
Distributor Action, described above, will have a material adverse effect on its
consolidated financial position, results of operations or cash flows because of,
among other reasons, the facts and circumstances existing with respect to each
action, the Company's belief that these actions are without merit, certain
defenses available to the Company and the availability of insurance in the
Securities Laws Actions.
See Item 7, "Management's Discussion and Analysis of Results of Operations and
Financial Condition--Product Liability; Insurance and Intellectual Property."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not Applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
The name, age and position held with the Company of each of the executive
officers of the Company are set forth below. No family relationship exists among
any of the executive officers.
NAME AGE POSITION
- ---- --- --------
E. R. (Ron) Pickard 48 Chairman and Chief Executive Officer, Sofamor Danek Group, Inc.
James J. Gallogly 48 President and Chief Operating Officer, Sofamor Danek Group, Inc.
R. L. (Lew) Bennett 70 Senior Vice President, Sofamor Danek Group, Inc.
Richard E. Duerr, Jr. 50 Vice President, General Counsel and Secretary, Sofamor Danek Group, Inc.
Peter J. Elkhuizen 47 President, Sofamor Danek Europe
Laurence Y. Fairey 46 Executive Vice President and Chief Financial Officer, Sofamor Danek
Group, Inc.
Mark D. LoGuidice 41 President, Sofamor Danek USA
J. Mark Merrill 37 Vice President, Treasurer and Assistant Secretary, Sofamor Danek Group,
Inc.
Dr. Marie-Helene Plais 47 Executive Vice President, Sofamor Danek Group, Inc.
Gene B. Sponseller 40 President of Manufacturing, Sofamor Danek USA
Richard W. Treharne, Ph.D. 47 Vice President of Research and Regulatory Affairs, Sofamor Danek Group,
Inc.
Don W. Urbanowicz 41 Executive Vice President of Marketing, Sofamor Danek USA
The executive officers of the Company serve at the discretion of the Board of
Directors and are elected annually. The following is a brief description of the
previous business background of each of the executive officers.
Mr. Pickard was President and Chief Operating Officer of the Company from August
1990 until becoming President and Chief Executive Officer on April 1, 1991 and
Chairman and Chief Executive Officer on May 23, 1994. From 1968 until joining
the Company, Mr. Pickard was employed by Richards Medical Company in varying
capacities including Director of Manufacturing (1975-78), Group Director of
Manufacturing (1979-1981), Vice President, Manufacturing (1982-1985), and
President, Orthopaedics Division (1986-90). Mr. Pickard was appointed as
Director of the Company in February 1991.
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Mr. Gallogly has been President and Chief Operating Officer of the Company since
June 1994. From 1988 to 1994, he was President and Chief Executive Officer of
ReSound Corporation. From 1981 to 1988, Mr. Gallogly held senior executive
positions at Richards Medical Company, including President of the Microsurgery
Division (1986-1988), Senior Vice President of Microsurgery (1982-1985), and
Vice President of Finance and Administration (1981-1982). Prior to 1981, he was
employed by Johnson & Johnson, where he held a variety of executive positions.
Mr. Bennett has been Senior Vice President of the Company since January 1992.
Mr. Bennett joined the Company in January 1991 as Senior Vice President-Sales
and Marketing. He has been active in the medical industry for over 35 years,
including tenures as divisional sales manager for Ethicon and Vice
President-Sales and Vice President-Marketing for the United States, Canada and
the Far East for Howmedica, Inc. Ethicon is a division of Johnson & Johnson
that specializes in medical sutures. Howmedica, Inc. is an orthopaedic
company.
Mr. Duerr has been Vice President, General Counsel and Secretary since he joined
the Company in June 1991. Mr. Duerr was engaged in the private practice of law
prior to joining the Company. From October 1979 through May 1990, Mr. Duerr was
employed by Schering-Plough Corporation in a variety of domestic and
international capacities. He previously served as an Assistant United States
Attorney for the Eastern District of Kentucky and as a law clerk to the
Honorable Pierce Lively, Judge of the United States Court of Appeals for the
Sixth Circuit. He received his B.A. in 1969 from the University of Notre Dame
and is a 1972 graduate of the University of Louisville School of Law.
Mr. Elkhuizen joined Sofamor Danek Europe in November 1996 as President. During
the past 16 years, Mr. Elkhuizen has held senior executive positions, both in
Europe and North America including President of EuroMedical (1993-1996),
President of Datascope international (1992-1993), Managing Director of Valleylab
Europe (1983-1992) and General Manager of Sterisystems Canada (1980-1983).
Mr. Fairey joined Sofamor Danek USA in January 1991 as Vice
President-International. He was appointed a Vice President and the Chief
Financial Officer of the Company in October 1991 and promoted to Executive Vice
President and Chief Financial Officer in July 1992. Prior to joining Sofamor
Danek USA, Mr. Fairey was employed by Richards Medical Company since 1973 in
various positions, including Controller, Treasurer, Vice President Finance for
the International Division and his last position of Vice President of
International Operations. Mr. Fairey holds a B.S. degree in accounting and an
M.B.A. from the University of Memphis.
Mr. LoGuidice has been President of Sofamor Danek USA since February 1995.
Prior to that, he spent 16 years with United States Surgical Corporation, most
recently in the positions of Vice President of Marketing-Sutures and Vice
President of Sales. Mr. LoGuidice is a 1978 graduate of Colgate University and
received his M.B.A. from Pace University in 1984.
Mr. Merrill is Vice President, Treasurer and Assistant Secretary. He joined
the Company in October 1988. Mr. Merrill received his B.S. degree in
accounting from Christian Brothers University in 1981. He became a Certified
Public Accountant in 1983 and received his M.B.A. with a concentration in
finance from the University of Memphis in 1988.
Dr. Plais has been Executive Vice President of the Company since November 1996.
In August 1987, she joined the Company as Medical Director of Sofamor, became
Vice President of Marketing and Sales of Sofamor in 1989 and President of
Sofamor Danek Europe in 1993. Prior to joining the Company, she was a
consultant in genetic diseases in Brittany, France. Dr. Plais graduated from
the University of Paris as a M.D. and holds a Master's Degree in human biology.
Mr. Sponseller has been President of Manufacturing, Sofamor Danek USA since
September 1990. From 1984 to 1990, he was Vice President and General Manager of
Manufacturing Operations. During his career at the Company, he has been
responsible for most of its administrative and management functions, including
the sales and distribution system that was in place prior to the Company's
acquisition of Danek Medical.
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Dr. Treharne joined the Company in November 1990. In January 1991, he was
named Vice President of Regulatory and Clinical Affairs of the Company. Prior
to joining the Company, Dr. Treharne was with Richards Medical Company. Dr.
Treharne has a Ph.D. from the University of Pennsylvania and an M.B.A. from the
University of Memphis. In June 1991, Dr. Treharne was named Vice President of
Research and Regulatory Affairs and is presently in charge of the research and
regulatory efforts of the Company.
Mr. Urbanowicz has been Executive Vice President of Marketing of Sofamor Danek
USA since September 1995. From January 1987 until joining Sofamor Danek USA, Mr.
Urbanowicz held senior executive positions with Smith and Nephew Richards,
including President of the Perry Surgical Glove Division (1992-1995) and Senior
Vice President for Strategic Planning/Business Operations and Vice President of
Global Marketing for the Richards Orthopaedic Division. From 1980 to 1986, he
was employed by Pfizer's Howmedica Orthopaedic Division, where he held a variety
of marketing management positions. Mr. Urbanowicz is a 1977 graduate of Seton
Hall University. He received his M.B.A. from Seton Hall in 1980.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
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First Quarter Second Quarter Third Quarter Fourth Quarter
- --------------------------------------------------------------------------------
1996
High $35.75 $37.25 $30.88 $32.63
Low 23.50 24.63 21.00 23.75
- --------------------------------------------------------------------------------
1995
High $25.00 $25.25 $27.88 $29.88
Low 12.75 18.38 18.75 21.75
================================================================================
The Company's common stock is traded on the New York Stock Exchange under the
Symbol "SDG."
The table above sets forth the reported high and low prices of the common stock
as quoted on the New York Stock Exchange.
No cash dividends have been paid to date by the Company on its common stock. The
Company does not anticipate the payment of dividends in the foreseeable future.
Internally generated funds are retained by the Company for working capital
needs.
As of February 28, 1997, the Company had approximately 970 stockholders of
record.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
The following selected consolidated financial data as of and for each of the
years in the five-year period ended December 31, 1996 has been derived from the
audited financial statements of the Company. This data should be read in
conjunction with the Consolidated Financial Statements, the notes thereto and
Management's Discussion and Analysis of Results of Operations and Financial
Condition included elsewhere in this Annual Report.
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
- ------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
- ------------------------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
Net sales $244,525 $188,799 $161,677 $161,794 $121,019
Cost of goods sold 45,005 40,309 35,295 35,893 25,171
- ------------------------------------------------------------------------------------------------------------------
Gross profit 199,520 148,490 126,382 125,901 95,848
Operating expenses:
Selling, general and administrative 116,729 89,847 74,183 67,844 56,222
Research and development 15,926 13,980 11,572 11,488 7,903
License agreement acquisition charge - 45,337 - - -
Product liability litigation charge 50,000 - - - -
Royalty expenses discontinued subsequent to the
combination - - - 1,182 3,175
Distributor contract termination charge and
related amortization of short-term intangibles - - 10,000 - -
- ------------------------------------------------------------------------------------------------------------------
Total operating expenses 182,655 149,164 95,755 80,514 67,300
- ------------------------------------------------------------------------------------------------------------------
Income (loss) from operations 16,865 (674) 30,627 45,387 28,548
Other income (expense) 913 2,533 2,153 (179) 917
Interest expense (3,744) (2,794) (629) (193) (25)
Combination expense - - - (9,958) (1,000)
Non-recurring litigation award - - (2,225) - -
- ------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
provision (benefit) for and charge in lieu of income taxes 14,034 (935) 29,926 35,057 28,440
Provision (benefit) for and charge in lieu of income
taxes 1,293 (6,319) 6,052 14,429 10,570
- ------------------------------------------------------------------------------------------------------------------
Income from continuing operations 12,741 5,384 23,874 20,628 17,870
Loss from operations of discontinued segment - - - (153) (316)
Minority interest (1,474) (417) (97) (50) -
- ------------------------------------------------------------------------------------------------------------------
Net income $ 11,267 $ 4,967 $ 23,777 $ 20,425 $ 17,554
Net income per share - fully diluted (1,3) $0.44 $0.20 $0.97 $0.83 $0.73
Weighted average number of shares - fully diluted (3) 26,109 25,395 24,582 24,509 24,159
==================================================================================================================
BALANCE SHEET DATA:
Working capital $ 31,127 $ 77,139 $ 69,164 $ 59,441 $ 57,845
Total assets 319,161 196,613 141,792 120,597 110,787
Short-term debt 66,894 16,602 3,949 1,334 1,808
Long-term debt 12,300 28,125 5,324 1,103 9,845
Stockholders' equity (2) 139,826 122,929 111,456 92,806 76,634
- ------------------------------------------------------------------------------------------------------------------
(1) Primary earnings per share were approximately the same as fully diluted
earnings per share in each period presented above.
(2) The Company has never paid cash dividends on its common stock and does not
anticipate paying cash dividends in the foreseeable future.
(3) These amounts have been retroactively adjusted to reflect all stock splits
and for the presentation of combined weighted average shares outstanding;
shares of Sofamor S.A. common stock are shown at the equivalent number of
the Company's shares based on the exchange ratio as defined in the Stock
Exchange Agreement, dated as of March 28, 1993, among the shareholders of
Sofamor S.A. and the Company.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
The following table sets forth, for the periods indicated, selected financial
information expressed as a percentage of net sales and the period-to-period
percentage changes in such information.
AS A PERCENTAGE OF NET SALES PERIOD-TO-PERIOD CHANGE
YEARS ENDED DECEMBER 31, YEARS ENDED DECEMBER 31,
- --------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1996 VS 1995 1995 vs 1994
- --------------------------------------------------------------------------------------------------------------------
Net sales 100.0% 100.0% 100.0% 29.5% 16.8%
Cost of goods sold 18.4 21.4 21.8 11.7 14.2
- ----------------------------------------------------------------------------------
Gross profit 81.6 78.6 78.2 34.4 17.5
Operating expenses:
Selling, general and administrative 47.7 47.6 45.9 29.9 21.1
Research and development 6.5 7.4 7.2 13.9 20.8
License agreement acquisition charge - 24.0 - (100.0) 100.0
Distributor contract termination
charge and related amortization of
short-term intangibles - - 6.2 N/A (100.0)
Product liability litigation charge 20.5 - - 100.0 N/A
- ----------------------------------------------------------------------------------
Total operating expenses 74.7 79.0 59.3 22.5 55.8
Income (loss) from operations 6.9 (0.4) 18.9 2602.2 (102.2)
Other income 0.4 1.3 1.4 (64.0) 17.6
Interest expense (1.6) (1.4) (0.4) 34.0 344.2
Non-recurring litigation award - - (1.4) N/A (100.0)
- ----------------------------------------------------------------------------------
Income (loss) from continuing
operations before provision (benefit) for
and charge in lieu of income taxes 5.7 (0.5) 18.5 1601.0 (103.1)
Provision (benefit) for and charge in lieu
of income taxes 0.5 (3.3) 3.7 120.5 (204.4)
- ----------------------------------------------------------------------------------
Income from continuing operations 5.2 2.8 14.8 136.6 (77.4)
Minority interest (0.6) (0.2) (0.1) 253.5 329.9
- ----------------------------------------------------------------------------------
Net income 4.6% 2.6% 14.7% 126.8% (79.1)%
==================================================================================
OVERVIEW
During both 1996 and 1995, the Company attained record sales. The Company has
increased sales through growth in existing businesses, establishing direct sales
and marketing operations in key international countries, as well as the
development and strategic acquisitions of complementary products and
technologies.
During 1995, the Company formed a majority owned subsidiary in the Benelux
region; in 1996, direct operations were established in Australia, Canada, and
Puerto Rico, as well as 50% owned subsidiaries in Japan and Korea. The minority
shareholders of the Japanese and Korean subsidiaries continue to serve as
distributors of the Company in their respective countries. (See Note 11 to the
Consolidated Financial Statements.)
As of the end of the second quarter of 1994, the Company entered into an
agreement to terminate the exclusive U.S. distribution of the Sofamor product
lines by National Medical Specialties, Inc. ("NMS"). On July 1, 1994, the
Company began distributing Sofamor products in the United States at retail
pricing versus the distributor pricing previously charged to NMS.
Following is a summary of certain acquisitions of existing companies and the
rights to distribute products and provide services using new technologies: (See
Note 4 to the Consolidated Financial Statements.)
During the first quarter of 1995, the Company entered into a strategic alliance
with Genetics Institute, Inc. ("Genetics Institute") to provide biological
products for use in spinal applications. Pursuant to the Genetics Institute
agreement (the "G.I. Agreement"), the Company obtained exclusive North American
rights to recombinant human bone morphogenetic protein (rhBMP-2) for spinal
applications.
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In February of 1995, the Company acquired from Implex Corp., a privately held
company located in Allendale, New Jersey, the exclusive worldwide rights to
certain patented, proprietary material technologies and associated intellectual
property rights for spinal applications.
In March 1995, Sofamor Danek purchased 19.5% of the outstanding stock of
Surgical Navigation Technologies, Inc. ("SNT") and acquired the exclusive
worldwide license (except in Korea until 1997) to manufacture and distribute SNT
products relating to frameless stereotactic surgery in spinal and neurological
fields. In May 1996, the Company acquired the remaining 80.5% of the outstanding
stock of SNT.
In July 1996, the Company acquired certain net assets of TiMesh, Inc., a
privately held company located in Las Vegas, Nevada. The net assets acquired are
used in the design, manufacture and marketing of titanium plates and titanium
alloy screws.
Also in July 1996, the Company acquired all of the capital stock of MedNext,
Inc., a privately held company located in West Palm Beach, Florida that designs,
manufactures and markets powered surgical instrumentation and accessories for
surgical specialties.
In August 1996, the Company entered into an exclusive agreement with The
University of Florida Tissue Bank, Inc. to provide services related to their
cortical bone dowel and other allograft bone products.
In December 1996, the Company acquired all of the capital stock of Colorado,
S.A., a privately held company located in Saint Genis Laval, France that
designs, manufactures and markets a spinal implant system for deformities and
lumbar disorders of the spine.
RESULTS OF OPERATIONS
Years ended December 31, 1996 and 1995
The Company achieved record net sales for the year ended December 31, 1996 of
$244.5 million, which represented a $55.7 million, or 29.5%, increase from sales
of $188.8 million for the year ended December 31, 1995. Net sales growth
included an increase of 8.5% that resulted from the Company's conversion of
certain portions of its international distribution network to direct sales which
resulted in higher selling prices. Other net pricing changes in existing
distribution channels resulted in a 3.9% increase in net sales. Additional sales
volume comprised the remainder of the increase in net sales. Changes in exchange
rates had an immaterial impact on net sales when comparing the Company's 1996
sales with 1995.
U.S. sales increased 28.4% to $162.2 million, as compared with $126.3 million
in 1995. The Company believes the improvement in U.S. sales is primarily the
result of an increased number of instrumented fusions, as well as the
acceptance of new products such as the STEALTHSTATION(TM) system, the
TIMESH(TM) cranial plating system, and the MEDNEXT(R) surgical drill system.
Non-U.S. sales increased 31.7% to $82.3 million, as compared with $62.5 million
in 1995. The strong international sales growth during 1996, compared with 1995,
primarily reflects the Company's strategy of establishing a direct sales
presence in selected countries and the acceptance of the new products mentioned
in the preceding paragraph, as well as enhanced international sales and
marketing programs.
The Company's gross margin improved to 81.6% in 1996 from 78.6% in 1995. The
enhancement in gross margin is due to higher margins relating to changes in
international distribution, greater leveraging of manufacturing costs due to
increased volume, a reduction in the levels of outsourced product manufacturing
and favorable shifts in the sales mix of certain products and sales programs.
Selling, general and administrative expenses were 47.7% of sales in 1996
compared with 47.6% of sales in 1995. The 1996 selling, general, and
administrative expenses as a percentage of sales compared to 1995 were slightly
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higher due to the effects of expenses related to establishing a direct sales
presence in selected countries. The higher expenses were mostly offset by the
leveraging of other fixed costs over greater sales volume in existing
operations.
Research and development expenses totaled $15.9 million or 6.5% of net sales in
1996 compared with $14.0 million or 7.4% of net sales in 1995. The 1996 dollar
spending represents an increase of 13.9% over 1995. These costs are incurred as
the Company continues to enhance existing product lines and develop new and
complementary products for use in spinal surgery, such as interbody fusion
devices, biological products for use in spinal reconstruction, and products
related to frameless stereotactic surgery in the spinal and neurological fields
of use. These expenditures demonstrate the Company's continued commitment to the
pursuit of applying new medical technologies to product opportunities.
In 1995, as a result of the G.I. Agreement, a special charge of $45.3 million
was recorded. The special charge consisted of $45.2 million, which is the net
present value of the $50.0 million in scheduled payments due under the
agreement, plus related transaction costs of $122,000. The charge resulted in an
after-tax impact of $1.16 per share for the year ended December 31, 1995.
During 1996, the Company recorded a special product liability litigation charge
of $50.0 million. This charge was recorded in order to recognize the reasonably
anticipated costs associated with the defense and conclusion of certain product
liability cases in which the Company is named as defendant. The Company believes
that these lawsuits are without merit and unfounded. (See Note 15 to the
Consolidated Financial Statements.)
The Company reported net other income of $913,000 in 1996 compared with $2.5
million during 1995. Other income was higher during 1995 due mainly to the
reversal of certain risk provisions and greater foreign exchange gains. Interest
expense was $3.7 million in 1996, representing a $950,000 increase over 1995.
The increase in interest expense was due to increased borrowings against the
Company's credit facilities occurring principally as a result of the
acquisitions described in the Overview Section.
The Company recorded income tax expense of $1.3 million in 1996 and an income
tax benefit of $6.3 million in 1995. The difference between the Company's
effective and statutory tax rates for both 1996 and 1995 resulted primarily from
the impact of certain elections made for U.S. tax purposes following the
combination (the "Combination") of Danek Group, Inc. with Sofamor S.A.
("Sofamor"), and the subsequent reorganization of Sofamor from a Societe Anonyme
(S.A.) under French law to a Societe en Nom Collectif (S.N.C.) in late 1993.
Management cannot be certain that such a favorable effective income tax rate
will be achieved in future periods, since the effective tax rate calculation is
dependent upon the Company's pre-tax income dollar amount. Higher future pre-tax
income could lead to higher future effective tax rates. At December 31, 1996,
the balance sheet of the Company reflected a net deferred tax asset of $38.2
million. No valuation allowance was recorded since sufficient taxable income
exists in available carryback periods to recognize fully these net deferred tax
assets. (See Note 12 to the Consolidated Financial Statements.)
Management believes that inflation has not had a material impact on the
Company's business.
Years ended December 31, 1995 and 1994
The Company experienced record net sales for the year ended December 31, 1995 of
$188.8 million, which represented a $27.1 million, or 16.8%, increase from sales
of $161.7 million for the year ended December 31, 1994. Increased volume of
10.3% was the primary component of the sales improvement. Net pricing changes
were responsible for an increase of 4.7% and the effects of a weaker dollar in
1995 compared with 1994 resulted in a favorable impact on sales of 1.8%.
U.S. sales increased 14.4% to $126.3 million as compared with $110.4 million in
1994. The Company believes the improvement in U.S. sales, which had declined
during 1994, was due, in part, to an improvement in the regulatory and legal
outlook for the spinal industry. The improvement was related to the events
discussed below which occurred in 1995. In February 1995, the Federal judge
supervising the multi-district product liability litigation denied class
certification. During 1995, 14 Section 510(k) clearances were received, which
was a record for the
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Company. One of these Section 510(k) clearances allowed the Company to begin
marketing its stainless steel version of the TSRH(R) spinal system for pedicle
screw attachment for treating patients with grade 3 or 4 severe
spondylolisthesis of the L5-S1 vertebral joint. The clearance is limited to
patients who are receiving fusions using autogenous bone graft only, having the
device fixed or attached to the lumbar and sacral spine and having the device
removed after the development of a solid fusion mass. Also, the Food and Drug
Administration's ("FDA") proposed classification, reclassification and
codification of pedicle screw spinal systems was published in the Federal
Register in early October 1995. The Company believes that this proposed rule is
reflective of the FDA's position on the use of bone screws in the pedicle of the
spine and is the result of the FDA's analytical review of the 1994 FDA Advisory
Panel's recommendation, a large historical cohort study and medical literature,
as well as data from clinical studies sponsored by several companies.
Non-U.S. sales advanced 21.8% to $62.5 million as compared with $51.3 million in
1994. Management believes that the international sales growth during 1995
compared with 1994 reflected the Company's enhanced international sales and
marketing programs. Sales were also bolstered by the initial favorable impact in
those countries where changes in the Company's distribution system were made to
further enhance marketing and profit opportunities.
The Company's gross margin as a percentage of net sales improved to 78.6% in
1995 from 78.2% in 1994. The percentage improvement was primarily the result of
manufacturing cost reduction programs and favorable shifts in the sales mix of
certain products and sales programs.
Selling, general and administrative expenses increased to 47.6% of sales in 1995
compared with 45.9% of sales in 1994. The 1995 increase as a percentage of sales
when compared to 1994 was primarily due to higher legal and other professional
fees incurred in connection with various legal and regulatory matters, as well
as certain commission expenses resulting from the change in distribution of
Sofamor products in the U.S.
Research and development expenses totaled $14.0 million, or 7.4%, of net sales
in 1995 compared with $11.6 million, or 7.2%, of net sales in 1994. These costs
were incurred as the Company continued to enhance existing product lines and to
develop new and complementary products for use in spinal surgery, such as
interbody fusion devices, biological products for use in spinal applications and
products related to frameless stereotactic surgery in the spinal and
neurological fields of use.
As a result of the G.I. Agreement, a special charge of $45.3 million was
recorded. The special charge consisted of $45.2 million, which is the net
present value of the $50.0 million in scheduled payments due under the agreement
plus related transaction costs of $122,000. The charge resulted in an after-tax
impact of $1.16 per share for the year ended December 31, 1995.
In connection with the NMS transaction, distributor contract termination expense
and related amortization of short-term intangibles totaling $10.0 million were
recorded as a special charge to earnings and resulted in an after-tax impact of
$0.27 per share for the year ended December 31, 1994.
The non-recurring litigation award of $2.2 million resulted from the ruling of a
Magistrate of the Commercial Court in Paris, which occurred during 1994, on a
claim of wrongful termination of the distribution agreement in favor of the
Company's former Spanish distributor of Sofamor's products. The Company has
appealed this ruling. The appeal process requires a retrial of all issues and is
still ongoing. (See Note 15 to the Consolidated Financial Statements.)
The Company reported net other income of $2.5 million or 1.3% of sales for 1995
compared with $2.2 million or 1.4% of sales for 1994. Foreign exchange gains
were the primary component of the increase. Interest expense for 1995 was $2.8
million as compared with $629,000 in 1994. The increase in interest expense
resulted primarily from the imputed interest under the G.I. Agreement.
The Company recorded an income tax benefit of $6.3 million in 1995 and an income
tax expense of $6.1 million in 1994. The tax benefit resulted primarily from the
special license agreement acquisition charge to earnings of $45.3 million
described above. The difference between the Company's effective and statutory
tax rates for both 1995 and
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1994 resulted primarily from the impact of the effects of certain elections made
for U.S. tax purposes following the Combination, and the subsequent
reorganization of Sofamor from a Societe Anonyme (S.A.) under French law to a
Societe en Nom Collectif (S.N.C.) in late 1993. Management cannot be certain
that such a favorable effective income tax rate will be achieved in future
periods, since the effective tax rate calculation is dependent upon the
Company's pre-tax income dollar amount. Higher future pre-tax income could lead
to higher future effective tax rates. At December 31, 1995, the balance sheet of
the Company reflected a net deferred tax asset of $19.8 million. No valuation
allowance was recorded since sufficient taxable income exists in available
carryback periods to recognize fully these net deferred tax assets. (See Note 12
to the Consolidated Financial Statements.)
Management believes that inflation has not had a material impact on the
Company's business.
LIQUIDITY AND CAPITAL RESOURCES
Cash generated from operations and the Company's revolving lines of credit are
the principal sources of funding available for the growth of the business,
including working capital and additions to property, plant and equipment, as
well as debt service requirements and required contractual payments. Cash, cash
equivalents and short-term investments totaled $2.9 million at December 31, 1996
compared with $13.3 million at December 31, 1995.
In connection with the formation of the subsidiary in Japan, Kobayashi Sofamor
Danek, K.K. ("KSD"), the Company is required to pay commissions based on the
sales of KSD to Kobayashi Pharmaceutical Co., Ltd. ("KPC"), which has served as
the Company's distributor in Japan and is the other shareholder in KSD. Payments
of $26.7 million were made to KPC during 1996 as prepayment of commissions.
In connection with the G.I. Agreement, the Company has recorded a liability of
$23.0 million at December 31, 1996, which represents the present value of the
$25.0 million in remaining scheduled payments. Of this amount, $7.0 million is
classified as long-term debt and $16.0 million is reflected as a current
liability, representing the principal portion of the $17.5 million payable on
June 30, 1997. The final payment of $7.5 million is due in June of 1998.
The Company's working capital decreased $46.0 million during 1996. The change in
working capital was primarily due to the payments required in connection with
the acquisitions of SNT, MedNext, Inc., Colorado S.A., and certain net assets of
TiMesh, Inc. totaling $38.8 million, the $26.7 million prepayment of commissions
to KPC, the $12.5 million payment due under the G.I. Agreement and the $6.2
million increase in the current portion of the Genetics Institute obligation.
These uses of working capital were partially offset by favorable cash flows from
ongoing operations. Net accounts receivable increased $19.6 million from
December 31, 1995, due primarily to the increase in net sales. Inventories and
loaner set inventories increased $11.1 million due to stocking levels required
for recently formed subsidiaries, the manufacture of loaner set inventories in
preparation for new sales and marketing programs and additional inventory
acquired in connection with the 1996 acquisitions described above. Other
receivables increased $6.6 million from the Company's previous year-end,
primarily due to amounts recoverable from the Company's insurance carriers
related to expenses incurred in connection with product liability litigation.
The purchase agreements for two of the acquisitions outlined in the Overview
section contain provisions which provide for contingent payments to the former
shareholders of each entity based upon certain calculations relative to revenues
and earnings, as defined, through 1999. Such payments will be reflected as
purchase price adjustments. During 1996, the Company recorded an adjustment to
the purchase price of one of these acquisitions by approximately $4.2 million.
The Company is unable to determine whether such payments will be required for
the years 1997 through 1999.
Additions to property, plant and equipment during 1996 of $7.1 million were
related to capital assets acquired in the formation and acquisition of new
subsidiaries and other capital expenditures necessary to support the Company's
manufacturing and distribution operations. The Company is in need of additional
office and distribution space at its Memphis location. The Company is currently
considering the alternatives of constructing or leasing a new facility. It is
estimated that the capitalized cost of the project, if constructed, would be
approximately $11.0 million. Net
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intangible assets increased by $53.8 million from December 31, 1995, primarily
due to the intangible assets relative to the acquisitions of SNT, MedNext, Inc.,
Colorado S.A., and certain net assets of TiMesh, Inc.
The Company has committed lines of credit totaling approximately $64.7 million.
At December 31, 1996, $50.2 million was outstanding under the Company's lines of
credit and other short-term borrowings. The lines of credit consist primarily of
a $50.0 million uncollateralized revolving line of credit with a U.S. bank which
is renewable annually and matures October 15, 1997. This line of credit was
increased to $60.0 million as of January 31, 1997. The Company has the option to
convert the debt outstanding under this revolving line of credit to a term loan,
amortized on a quarterly basis over a term of up to three years.
The Company invests available funds in short-term investment grade instruments,
certificates of deposit or direct or guaranteed obligations of the United States
of America. These short-term investments are available to fund the Company's
working capital requirements and acquisitions of capital assets.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS AND FINANCIAL CONDITION
The Company's future operating results and financial condition are subject to
risks and uncertainties, including (without limitation) the following matters:
Regulatory Clearances. The Company manufactures devices that are subject to the
regulations of the FDA and, in some cases, to the regulations of foreign
governmental authorities. In particular, such devices are subject to marketing
clearance by the FDA before sales can be made in the United States. The process
of obtaining marketing clearances can be time consuming, and there can be no
assurance that all necessary clearances will be granted to the Company with
respect to new devices or that the FDA review will not involve delays adversely
affecting the marketing and sale of new products and devices by the Company. The
enforcement of FDA regulations depends heavily on administrative interpretation,
and there can be no assurance that future interpretations made by the FDA or
other regulatory bodies, with possible retroactive effect, will not adversely
affect the Company. The Company cannot predict the extent or impact of future
foreign, federal, state or local legislation or regulation.
Potential Impact of Health Care Cost Containment Proposals on Profitability. In
recent years, the cost of health care has risen significantly, and there have
been numerous proposals by legislators, regulators and third party health care
payers to curb these cost increases in the United States and Europe. Some of
these proposals have involved limitations on the amount of reimbursement for
specific surgical procedures. These proposals have been adopted in some cases.
The Company is unable to predict what changes will be made in the reimbursement
methods utilized by third party health care payers. In addition, hospitals and
other health care providers have become increasingly cost sensitive. To date,
the Company does not believe that such health care cost containment proposals
have negatively affected the profitability or growth of its business; however,
the Company is not able to predict the future effect of these proposals on its
business.
Product Obsolescence. Spinal implant and other devices are subject to continuous
improvements and modifications and typically are rendered obsolete within a few
years. Success, therefore, requires any medical device company to devote
substantial resources to continued product development. The Company maintains
active research and development programs and has been successful in developing
new products in the past. There can be no assurance that the Company will be
able to develop and introduce new products that will enable it to remain
competitive in the future.
Product Liability; Insurance. In recent years, physicians, hospitals, and other
participants in the health care industry have become subject to an increasing
number of lawsuits alleging malpractice, product liability or asserting related
legal theories, many of which involve large claims and significant defense
costs. The Company currently maintains liability insurance intended to cover
such claims, although there can be no assurance that the coverage limits of such
insurance policies will be adequate or that all amounts will ultimately be
collected from each insurer providing the applicable policy. Such insurance is
expensive, difficult to obtain and may not be available in the future on
acceptable terms or at all. The Company is currently involved in product
liability litigation. (See Note 15 to the Consolidated Financial Statements.)
There can be no assurance that additional claims will not be asserted against
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the Company in the future. A successful future claim or aggregation of future
claims brought against the Company in excess of insurance coverage could have a
material adverse effect upon the financial condition, results of operations
and/or cash flows of the Company. Claims against the Company, regardless of
their merit or eventual outcome, may also have a material adverse effect upon
the reputation and business of the Company.
Competition. Worldwide, there are a number of firms producing spinal implant
devices. The Company currently competes with a number of firms with financial,
marketing and technical resources comparable to or greater than those of the
Company. Because of the growth of the number of spinal fusion procedures
performed in recent years, a number of companies, including those active in
producing various orthopaedic and neurological products and having financial,
marketing and technical resources significantly greater than those of the
Company, have begun producing spinal implant devices. The Company anticipates
that additional companies may also begin such production.
Retention of Personnel. The Company is highly dependent upon its senior
management, and the competition for qualified management personnel is intense.
The loss of key personnel or an inability to attract, retain and motivate such
persons could adversely affect the business and prospects of the Company. There
can be no assurance that the Company will be able to retain its existing senior
management personnel or to attract additional qualified personnel if needed. The
Company also depends on its contractual relationships with certain physicians
for product ideas, research and advice. There can be no assurance that the
Company will be able to maintain and develop such relationships.
Global Market Risks. A significant portion of the Company's revenue is derived
from its international operations. As a result, the Company's operations and
financial results could be affected by international factors, such as changes in
foreign currency exchange rates or weak economic conditions in the foreign
markets in which the Company distributes its products.
Intellectual Property. The Company is dependent on its proprietary intellectual
property and attempts to protect such intellectual property through patents,
licensing, trade secrets and proprietary know-how. In the medical device
industry, challenges by third parties regarding intellectual property rights
occur frequently. Such challenges may result in litigation which is often
complex and expensive. There can be no assurance that the Company's proprietary
rights will not be challenged, rendered unenforceable or circumvented and that
pending or future patent or trademark applications will be granted.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES/REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors
Sofamor Danek Group, Inc.
We have audited the consolidated balance sheets of Sofamor Danek Group, Inc. and
Subsidiaries as of December 31, 1996 and 1995, and the related consolidated
statements of income, changes in stockholders' equity and cash flows for each of
the three years in the period ended December 31, 1996. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated 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 consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Sofamor
Danek Group, Inc. and Subsidiaries as of December 31, 1996 and 1995, and the
results of their consolidated operations and their cash flows for each of the
three years in the period ended December 31, 1996 in conformity with generally
accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Memphis, Tennessee
January 31, 1997
24
28
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
(IN THOUSANDS, EXCEPT SHARES)
- ----------------------------------------------------------------------------------------
1996 1995
- ----------------------------------------------------------------------------------------
ASSETS
- ----------------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents $ 2,830 $ 11,330
Short-term investments 111 1,924
Accounts receivable -- trade, less allowance for
doubtful accounts of $1,589 and $1,555 at
December 31, 1996 and 1995, respectively 70,031 50,451
Other receivables 15,813 9,257
Inventories 33,483 25,723
Loaner set inventories 14,123 10,803
Prepaid expenses 6,318 5,092
Prepaid income taxes -- 2,648
Current deferred income taxes 5,312 4,699
- ----------------------------------------------------------------------------------------
Total current assets 148,021 121,927
Property, plant and equipment
Land 1,484 1,505
Buildings 11,261 10,878
Machinery and equipment 32,083 25,723
Automobiles 708 231
- ----------------------------------------------------------------------------------------
45,536 38,337
Less accumulated depreciation (20,026) (15,714)
- ----------------------------------------------------------------------------------------
25,510 22,623
Investments 920 3,600
Intangible assets, net 83,426 29,600
Other assets 28,282 3,597
Non-current deferred income taxes 33,002 15,266
- ----------------------------------------------------------------------------------------
Total assets $ 319,161 $ 196,613
========================================================================================
LIABILITIES
Current liabilities:
Notes payable and lines of credit $ 50,207 $ 6,516
Current maturities of long-term debt 16,687 10,086
Accounts payable 7,332 6,513
Accrued foreign income taxes 3,898 539
Accrued expenses 38,770 21,134
- ----------------------------------------------------------------------------------------
Total current liabilities 116,894 44,788
Long-term debt, less current maturities 12,300 28,125
Deferred income taxes 121 191
Product liability litigation 48,000 --
Minority interest 2,020 580
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, no par value, 5,000,000 shares
authorized, no shares outstanding
Common stock, no par value, 150,000,000 shares
authorized; 25,094,277 and 24,672,131 shares
issued (including 685,908 and 678,433 shares held in
treasury) at December 31, 1996 and 1995, respectively 52,994 44,832
Retained earnings 98,044 86,777
Cumulative translation adjustment 2,542 5,542
- ----------------------------------------------------------------------------------------
153,580 137,151
Less:
Cost of common stock held in treasury (9,985) (9,736)
Unearned compensation (54) (321)
Stockholder notes receivable (3,715) (4,165)
- ----------------------------------------------------------------------------------------
Total stockholders' equity 139,826 122,929
- ----------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 319,161 $ 196,613
========================================================================================
The accompanying notes are an integral part of the
consolidated financial statements.
25
29
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- ----------------------------------------------------------------------------------------------------------------
1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------
Net sales $ 244,525 $ 188,799 $ 161,677
Cost of goods sold 45,005 40,309 35,295
- ----------------------------------------------------------------------------------------------------------------
Gross profit 199,520 148,490 126,382
Operating expenses:
Selling, general and administrative 116,729 89,847 74,183
Research and development 15,926 13,980 11,572
License agreement acquisition charge -- 45,337 --
Product liability litigation charge 50,000 -- --
Distributor contract termination charge and related
amortization of short-term intangibles -- -- 10,000
- ----------------------------------------------------------------------------------------------------------------
Total operating expenses 182,655 149,164 95,755
- ----------------------------------------------------------------------------------------------------------------
Income (loss) from operations 16,865 (674) 30,627
Other income 913 2,533 2,153
Interest expense (3,744) (2,794) (629)
Non-recurring litigation award -- -- (2,225)
- ----------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before provision
(benefit) for and charge in lieu of income taxes 14,034 (935) 29,926
Provision (benefit) for and charge in lieu of income
taxes 1,293 (6,319) 6,052
- ----------------------------------------------------------------------------------------------------------------
Income from continuing operations 12,741 5,384 23,874
Minority interest (1,474) (417) (97)
- ----------------------------------------------------------------------------------------------------------------
Net income $ 11,267 $ 4,967 $ 23,777
Primary and fully diluted net income per share $ 0.44 $ 0.20 $ 0.97
================================================================================================================
The accompanying notes are an integral part of the
consolidated financial statements.
26
30
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS, EXCEPT FOR SHARES)
Foreign
Currency Unearned Stockholders'
Number of Common Retained Translation Treasury Compen- Notes
Shares Stock Earnings Adjustment Stock sation Receivable Total
- ------------------------------------------------------------------------------------------------------------------------------------
Balances, January 1, 1994 24,369,838 $40,459 $58,033 $ (334) $(1,063) $(4,289) $ 92,806
Common stock issued 9,337 180 180
Repurchase of common stock (678,433) (9,736) (9,736)
Exercise of stock options 54,062 343 343
Income tax benefit from vesting
of restricted stock & stock
options exercised 254 254
Unearned compensation
amortization 370 370
Termination for stock grant 73 -
(73)
Stock issuance valuation
adjustment (392) (392)
Stockholders' contributed 500 500
capital
Stockholders' notes receivable 98 98
Net income 23,777 23,777
Cumulative translation
adjustment 3,256 3,256
- ------------------------------------------------------------------------------------------------------------------------------------
Balances, December 31, 1994 23,754,804 41,271 81,810 2,922 (9,736) (620) (4,191) 111,456
Common stock issued 7,241 146 146
Exercise of stock options 231,653 2,481 2,481
Income tax benefit from
vesting of restricted stock &
stock options exercised 934 934
Unearned compensation
amortization 299 299
Stockholders' notes receivable 26 26
Net income 4,967 4,967
Cumulative translation
adjustment 2,620 2,620
- ------------------------------------------------------------------------------------------------------------------------------------
Balances, December 31, 1995 23,993,698 44,832 86,777 5,542 (9,736) (321) (4,165) 122,929
COMMON STOCK ISSUED 4,702 137 5 142
REPURCHASE OF COMMON STOCK (7,775) (254) (254)
EXERCISE OF STOCK OPTIONS 417,744 5,437 5,437
INCOME TAX BENEFIT FROM
VESTING OF RESTRICTED STOCK &
STOCK OPTIONS EXERCISED 2,588 2,588
UNEARNED COMPENSATION
AMORTIZATION 267 267
STOCKHOLDERS' NOTES RECEIVABLE 450 450
NET INCOME 11,267 11,267
CUMULATIVE TRANSLATION
ADJUSTMENT (3,000) (3,000)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCES, DECEMBER 31, 1996 24,408,369 $52,994 $98,044 $2,542 $(9,985) $ (54) $(3,715) $139,826
===================================================================================================================================
The accompanying notes are an integral part of the
consolidated financial statements.
27
31
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS, EXCEPT FOR SHARES)
- -------------------------------------------------------------------------------------------------
1996 1995 1994
- -------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Income from continuing operations $ 12,741 $ 5,384 $ 23,874
Minority interest (1,474) (417) (97)
- -------------------------------------------------------------------------------------------------
Net income 11,267 4,967 23,777
Adjustments to reconcile net income to net
cash provided by
operating activities:
Depreciation and amortization 10,374 7,857 7,375
Provision for doubtful accounts receivable 705 366 965
Deferred income tax benefit (18,678) (15,955) (10)
License agreement acquisition charge -- 45,215 --
Gain (loss) on disposal of equipment 94 6 (13)
Accretion of investment discount -- -- (171)
Equity loss in unconsolidated affiliate 49 -- 261
Minority interest 1,474 417 97
Changes in assets and liabilities, net of
acquisitions:
Accounts receivable (19,606) (12,456) (1,042)
Other receivables (6,968) (6,515) 338
Inventories (9,777) 2,867 (9,870)
Prepaid expenses (1,142) (2,130) (404)
Prepaid income taxes 2,647 902 (3,502)
Other assets (26,709) (1,819) (77)
Accounts payable (357) 2,006 (2,717)
Accrued income taxes 6,186 1,440 (4,545)
Accrued expenses 13,353 3,553 1,803
Product liability litigation 48,000 -- --
- -------------------------------------------------------------------------------------------------
Net cash provided by operating activities 10,912 30,721 12,265
- -------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchase of short-term investments (116) (18,284) (34,607)
Proceeds from maturities of short-term
investments 1,899 17,633 35,781
Proceeds from sale of equipment 34 19 124
Payments for purchase of property,
plant and equipment (7,110) (4,604) (6,320)
Purchase of intangible assets (18,538) (8,893) (7,853)
Increase in notes receivable, other -- (27) (4)
Repayments of notes receivable, other 85 102 67
Acquisitions, net of cash acquired (33,953) -- --
Payments for investment -- (2,585) --
Purchase of minority interest (1,965) -- (88)
- -------------------------------------------------------------------------------------------------
Net cash used by investing activities (59,664) (16,639) (12,900)
- -------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Increase in short-term borrowings 43,839 3,146 2,265
Proceeds from long-term debt 871 172 123
Repayment of long-term debt (10,353) (12,954) (389)
Repayment of stockholders' notes receivable 450 26 98
Proceeds from issuance of common stock 5,574 2,627 523
Repurchase of common stock -- -- (9,736)
Capital contributions by minority stockholders 489 -- --
- -------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 40,870 (6,983) (7,116)
- -------------------------------------------------------------------------------------------------
28
32
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS CONTINUED
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS, EXCEPT FOR SHARES)
- -----------------------------------------------------------------------------------------
1996 1995 1994
- -----------------------------------------------------------------------------------------
Effect of exchange rate changes on cash (618) (156) 520
- -----------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (8,500) 6,943 (7,231)
Cash and cash equivalents, beginning of period 11,330 4,387 11,618
- -----------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 2,830 $ 11,330 $ 4,387
=========================================================================================
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ 4,605 $ 1,103 $ 502
Cash paid during the year for income taxes $ 11,015 $ 7,204 $ 11,614
- -----------------------------------------------------------------------------------------
Supplemental schedule of non-cash investing and financing activities:
- - In 1996, 1995 and 1994, net income tax benefits of $2,588, $934 and $254,
respectively, were realized by the Company as a result of certain common
stock options being exercised and the vesting of certain restricted common
stock, reducing accrued federal and state income taxes payable and
increasing common stock.
- - In January 1994, the Company purchased technology and rights to a medical
device valued at $5,000 in exchange for a non-negotiable, subordinated
convertible note with a principal amount of $4,500. The Company also
recorded the $500 differential as an increase in common stock.
- - In August 1994, the Company acquired various patented technologies and a
non-compete agreement valued at $8,600 from Citation Medical Corporation
("Citation"). These intangible assets were purchased in exchange for $2,000
in cash, Citation's stock, which the Company held as an investment of
$6,200, and the cancellation of a license agreement which carried a net
value of $400 on the Company's books. In addition, the Company adjusted the
value of its Citation investment, resulting in a decrease in common stock
of $392.
- - During 1995, the Company incurred a liability of $45,215 in connection with
the acquisition of a license agreement.
- - During 1996, $698 of accounts receivable were written-off against the
allowance for doubtful accounts.
The accompanying notes are an integral part of the
consolidated financial statements.
29
33
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except for shares and per share data)
1. ORGANIZATION, BASIS OF PRESENTATION AND NATURE OF OPERATIONS
ORGANIZATION
The consolidated financial statements of Sofamor Danek Group, Inc. (the
"Company") include the accounts of the Company and its subsidiaries. The Company
controls and owns 51% of a subsidiary in Belgium and 50% of two separate
subsidiaries in Japan and Korea. All other subsidiaries are wholly owned.
Minority interest represents minority stockholders' proportionate share of the
equity in the subsidiaries. All significant intercompany balances, transactions
and profits have been eliminated in consolidation.
BASIS OF PRESENTATION
The consolidated financial statements are prepared on the basis of generally
accepted accounting principles. 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 at December 31, 1996 and 1995 and reported amounts of revenues and
expenses for each of the three years in the period ended December 31, 1996.
Significant estimates include those made for product liability litigation, the
allowance for doubtful accounts, inventory reserves for excess, obsolete and
damaged products, depreciation and amortization. Actual results could differ
from those estimates made by management.
NATURE OF OPERATIONS
The Company primarily develops, manufactures and markets spinal devices used in
the surgical treatment of spinal disorders.
The Company has subsidiaries located throughout North America, Europe, Asia and
Australia and has manufacturing facilities located in Indiana, Nevada, Florida,
Colorado, and France. Products are sold primarily to hospitals, either directly
or through distributors.
A significant portion of the Company's revenue is derived from its international
operations. As a result, the Company's operations and financial results could be
affected by international factors such as changes in foreign currency exchange
rates or weak economic conditions in the international markets in which the
Company distributes its products. In addition, inherent in the accompanying
consolidated financial statements are certain risks and uncertainties. These
risks and uncertainties include, but are not limited to: timely development and
acceptance of new products, impact of competitive products, timely receipt of
regulatory clearances required for new products, regulation of current products,
potential impact on health care cost containment proposals on profitability,
product obsolescence, the availability of product liability insurance,
disposition of certain litigation matters and cash balances in excess of
federally insured limits.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH EQUIVALENTS
The Company considers all highly liquid investments with a remaining maturity of
three months or less when purchased to be cash equivalents.
30
34
INVESTMENTS
Investments represent the Company's investments in unconsolidated affiliates.
Investments over which the Company exerts significant influence, but does not
control the financial and operational direction, are accounted for using the
equity method of accounting. All other investments are recorded at cost.
INVENTORIES AND LOANER INVENTORIES
Inventories and loaner inventories are stated at the lower of cost (determined
principally by the first-in, first-out method) or market. The Company maintains
a reserve for its estimate of excess, obsolete and damaged goods based on
historical and forecasted usage.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, including certain equipment acquired under
capital leases, are stated at cost. Property and equipment are depreciated on a
straight-line basis over their estimated useful lives which range from 3 to 40
years. Assets acquired under capital leases are amortized over the term of the
underlying lease. Amortization expense of assets under capital leases and
depreciation expense for the years ended December 31, 1996, 1995, and 1994
totaled $5,449, $4,366 and $4,103, respectively.
Amounts expended for maintenance and repairs are charged to expense as incurred.
Upon disposition, both the related cost and accumulated depreciation accounts
are relieved and the related gain or loss is credited or charged to operations.
REVENUE RECOGNITION
Sales are recognized primarily upon the shipment of products to the customer or
distributor. The Company derives revenues from both sales of products and
certain service functions. The revenues from services are insignificant and
accordingly are included in net sales.
Concentration of credit risk with respect to trade accounts receivable is
generally diversified due to the large number of entities comprising the
Company's customer base. The Company performs ongoing credit evaluations and
provides an allowance for potential credit losses against the portion of
accounts receivable which is estimated to be uncollectible. Such losses have
historically been within management's expectations.
INCOME TAXES
The provision for income taxes and corresponding balance sheet accounts are
determined in accordance with SFAS No. 109, "Accounting for Income Taxes" ("SFAS
109"). Under SFAS 109, deferred tax liabilities and assets are determined based
on temporary differences between the bases of certain assets and liabilities for
income tax and financial reporting purposes.
The deferred tax assets and liabilities are classified according to the
financial statement classification of the assets and liabilities generating the
differences. Valuation allowances are established when necessary to reduce
deferred tax assets to the amount expected to be realized.
FOREIGN CURRENCY TRANSLATION
All balance sheet accounts denominated in a currency other than U.S. dollars are
translated into U.S. dollars at the current exchange rate as of the end of the
accounting period. Income statement items are translated at weighted-average
currency exchange rates. The resulting translation adjustment is recorded as a
separate component of stockholders' equity. Gains and losses resulting from
foreign currency transactions denominated in a currency other than the
functional currency are included in net income and amounted to net gains during
1996, 1995, and 1994 of $632, $827, and $487, respectively. Gains and losses
relative to intercompany foreign currency transactions, for
31
35
which settlement is not planned or anticipated in the foreseeable future, are
excluded from net income and reported as cumulative translation adjustments.
TREASURY STOCK
The Company purchased 7,775 shares in 1996 and 678,433 shares in 1994 of its
common stock at an aggregate cost of approximately $254 and $9,736,
respectively. There were no shares purchased during 1995.
3. INVENTORIES AND LOANER INVENTORIES
Net inventories at December 31, 1996 and 1995 consist of the following:
- -------------------------------------------------------------------
1996 1995
- -------------------------------------------------------------------
Finished goods $28,260 $21,238
Work-in-process 2,961 3,017
Raw materials 2,262 1,468
- -------------------------------------------------------------------
Net inventories $33,483 $25,723
- -------------------------------------------------------------------
Loaner set inventories, net $14,123 $10,803
- -------------------------------------------------------------------
Loaner set inventories consist of inventory items on loan or available to be
loaned to customers. The inventory items used by the customer in surgery are
recorded as sales when used; the remaining inventory in the set is returned to
the Company.
4. ACQUISITIONS
During 1996, the Company completed four acquisitions which have been accounted
for utilizing the purchase method of accounting. Accordingly, the results of
operations of the acquired businesses, which are not significant to the
Company's consolidated results of operations, have been included in the
accompanying consolidated financial statements from their respective dates of
acquisition.
In March 1995, the Company purchased 19.5% of the outstanding stock of Surgical
Navigation Technologies, Inc. ("SNT"), a privately held company located in
Broomfield, Colorado. In conjunction with the purchase, the Company acquired the
exclusive worldwide license (except in Korea until 1997) to manufacture and
distribute SNT products relating to frameless stereotactic surgery in the spinal
and neurological fields. In May 1996, the Company acquired the remaining 80.5%
of the outstanding stock of SNT.
In July 1996, the Company acquired the net assets of TiMesh, Inc., a privately
held company located in Las Vegas, Nevada. The net assets acquired are used in
the design, manufacture, and marketing of titanium plates and titanium alloy
screws.
In July 1996, the Company acquired all of the capital stock of MedNext, Inc., a
privately held company located in West Palm Beach, Florida that designs,
manufactures and markets powered surgical instrumentation and accessories for
surgical specialties.
In December 1996, the Company acquired all of the capital stock of Colorado
S.A., a privately held company located in France. Colorado, S.A. designs and
markets certain spinal devices used in the surgical treatment of deformities and
lumbar disorders of the spine.
In connection with these acquisitions, the Company recorded certain loss
contingencies. The Company has estimated the fair value of these loss
contingencies, at the dates of acquisition, based on currently available
information. The Company does not believe that changes in these estimates will
have a material adverse effect on
32
36
its consolidated financial position, results of operations or cash flows;
however, material changes could significantly impact the final purchase price
allocation.
The purchase agreements for two of these acquisitions contain provisions which
provide for contingent payments to the former shareholders of each entity based
upon certain calculations relative to revenues and earnings, as defined, through
1999. Such payments will be reflected as purchase price adjustments. During
1996, the Company recorded an adjustment to the purchase price of one of these
acquisitions by $4,174. The Company is unable to determine whether such payments
will be required for the years 1997 through 1999.
The estimated fair values assigned to the assets and liabilities acquired were
as follows:
- -------------------------------------------------------------------------------
Total consideration paid (including amounts paid during 1995) $ 38,796
Fair value of liabilities assumed 6,935
Fair value of tangible and identifiable assets acquired (11,528)
- -------------------------------------------------------------------------------
Goodwill at acquisition date 34,203
Adjustment to purchase price during 1996 4,174
- -------------------------------------------------------------------------------
Goodwill for 1996 acquisitions $ 38,377
===============================================================================
5. INTANGIBLE ASSETS
Identifiable intangible assets and goodwill are recorded and amortized over
their estimated economic lives or periods of future benefit. The Company
amortizes goodwill on a straight-line basis over the estimated period of benefit
ranging from 15 to 20 years. Other identifiable purchased intangible assets are
amortized on a straight-line basis over their estimated period of benefit
ranging from 1 to 12 years. The lives established for these assets are a
composite of many factors which are subject to change because of the nature of
the Company's operations. This is particularly true for goodwill which reflects
value attributable to the going concern nature of acquired businesses, the
stability of their operations, market presence and reputation. Accordingly, at
each reporting period, the Company evaluates the continued appropriateness of
these lives and recoverability of the carrying value of such assets based upon
the latest available economic factors and circumstances. Impairment of value, if
any, is recognized in the period in which it is determined. The Company does not
believe that there are any facts or circumstances indicating impairment of
identifiable intangible assets and goodwill at December 31, 1996.
A summary of intangible assets at December 31, is as follows:
- ------------------------------------------------------------------
1996 1995
- ------------------------------------------------------------------
Goodwill $41,957 $ 1,399
Patents 33,960 24,240
Trademarks 1,767 1,350
License agreements 9,009 8,005
Non-compete agreements 6,528 2,325
Other 3,770 519
- ------------------------------------------------------------------
96,991 37,838
Less: accumulated amortization (13,565) (8,238)
- ------------------------------------------------------------------
$83,426 $29,600
==================================================================
6. LICENSE AGREEMENT ACQUISITION CHARGE
During 1995, the Company entered into a license agreement (the "Agreement") with
Genetics Institute, Inc. ("G.I.") to provide biological products for use in
spinal applications. The Agreement provides exclusive North American
distribution rights to the Company and requires annual payments through 1998
totaling $50,000. The Company charged $45,337 to operations during 1995 as
purchased research and development. This charge represents the net present value
of the total required payments pursuant to the Agreement plus related
transaction costs. The liability
33
37
recorded at December 31, 1996 represents the present value of the Company's
remaining obligation under the terms of the Agreement.
7. DISTRIBUTOR TERMINATION
During 1994, the Company entered into an agreement to terminate the exclusive
U.S. distribution of the Sofamor product lines by National Medical Specialties,
Inc. ("NMS"). On July 1, 1994, the Company began distributing Sofamor products
in the United States at retail pricing versus the distributor pricing
previously charged to NMS.
As a result of the Company discontinuing its relationship with NMS, a
distributor contract termination charge and the related amortization of
short-term intangibles of $10,000 was recorded as a charge to earnings during
1994.
8. FOREIGN OPERATIONS
The Company operates in predominately one industry. A summary of the Company's
operations by geographical areas for the three years ended December 31, 1996, is
set forth below:
- -------------------------------------------------------------------------------
1996 1995 1994
- -------------------------------------------------------------------------------
REVENUES:
North America $189,831 $147,025 $118,803
Europe/Asia 70,410 49,260 50,286
Eliminations (15,716) (7,486) (7,412)
- -------------------------------------------------------------------------------
Total revenues $244,525 $188,799 $161,677
===============================================================================
INCOME (LOSS) BEFORE TAXES:
North America $ 1,244 $ (5,995) $ 33,814
Europe/Asia 12,790 5,060 (3,888)
- -------------------------------------------------------------------------------
Total income (loss) before taxes $ 14,034 $ (935) $ 29,926
===============================================================================
Included in income (loss) before taxes was a product liability litigation charge
of $50,000 in North America during 1996, a license agreement acquisition charge
of $45,337 in North America during 1995, and a distributor contract termination
charge of $8,750 in Europe/Asia during 1994.
- --------------------------------------------------------------------
1996 1995
- --------------------------------------------------------------------
IDENTIFIABLE ASSETS:
North America $270,697 $151,952
Europe/Asia 67,421 53,305
Eliminations (21,898) (21,898)
- --------------------------------------------------------------------
Total identifiable assets 316,220 183,359
Corporate assets 2,941 13,254
- --------------------------------------------------------------------
Total assets $319,161 $196,613
====================================================================
Corporate assets are composed primarily of cash, cash equivalents and short-term
investments.
34
38
The following amounts are included in the consolidated financial statements for
international subsidiaries:
- ----------------------------------------------------------------------------------------
1996 1995 1994
- ----------------------------------------------------------------------------------------
Current assets $ 52,240 $ 40,499 $ 39,329
Property, plant and equipment 12,141 10,496 9,241
Intangible assets 6,303 5,909 4,032
Other assets, not itemized 2,629 1,561 2,420
- ----------------------------------------------------------------------------------------
73,313 58,465 55,022
- ----------------------------------------------------------------------------------------
Current liabilities 33,343 18,240 12,412
Net intercompany balance 8,430 8,853 13,504
Long-term liabilities 2,416 1,396 1,036
- ----------------------------------------------------------------------------------------
44,189 28,489 26,952
- ----------------------------------------------------------------------------------------
Net assets $ 29,124 $ 29,976 $ 28,070
========================================================================================
9. NOTES PAYABLE AND LINES OF CREDIT
At December 31, 1996 and 1995, the Company had a loan agreement with a bank,
which provided for borrowings of up to $50,000 and $40,000, respectively, under
a revolving line of credit. During 1996, the Company could borrow funds under
the loan agreement denominated in U.S. Dollars, French Francs, or Japanese Yen.
U.S. Dollar, French Franc and Japanese Yen borrowings under the line of credit
bear interest at rates of 0.625% above each of the 30-day adjusted LIBOR rate
(5.5% at December 31, 1996), PIBOR rate (3.50% at December 31, 1996) and TIBOR
rate (0.55% at December 31, 1996), respectively, and interest is payable
monthly. The Company must also pay a quarterly fee of 0.125% per annum on the
unused portion of the commitment. The loan agreement contains covenants which
include certain restrictions, such as minimum levels of tangible net worth,
minimum quarterly net income, and maintenance of an adequate debt service
coverage ratio. The Company had the equivalent of $35,087 outstanding under the
revolving line of credit at December 31, 1996, and no amount outstanding at
December 31, 1995.
At December 31, 1996, the Company also had several loan agreements with various
international banks. The aggregate maximum borrowings available under these
lines of credit were equivalent to approximately $14,711 and bear interest at
rates ranging from 1.625% to 14.25%. The Company had approximately $15,120
outstanding under the revolving lines of credit and various other short-term
borrowings at December 31, 1996.
The Company's weighted average interest rate on short-term borrowings was
approximately 6.5% at December 31, 1996 and 1995.
10. LONG-TERM DEBT
In connection with the acquisition of the G.I. Agreement, the Company has
recorded long-term debt equal to the net present value of the future annual
payments (calculated at inception based on the Company's implicit borrowing rate
of 6.75%). Interest expense is recognized ratably over the term of the
agreement. The Company recognized interest expense of $1,880 and $1,650 relative
to this agreement during 1996 and 1995, respectively.
During January 1994, the Company signed an agreement with an individual to
acquire various technologies valued at $5,000. In exchange, the Company issued a
non-negotiable, subordinated convertible note. The note, in the principal sum of
$4,500, is due January 11, 2004, and bears interest at a rate equal to the rate
that the Company actually earns on its investments calculated on an annual
basis. Interest is payable annually. At any time after January 11, 1996, at the
election of the individual, the note may be converted into 178,571 shares of
common stock of the Company. The Company recorded the $500 differential between
the value of technologies and the principal sum of the note as an increase in
common stock.
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Long-term debt at December 31, 1996 and 1995 consists of:
- -------------------------------------------------------------------------------
1996 1995
- --------------------------------------------------------------------------------
Present value of amounts due under the G.I. Agreement $ 22,998 $ 32,715
Subordinated convertible note 4,500 4,500
Various term loans with banks at fixed interest rates
from 0% to 9% maturing from 1997 to 1999 with annual
installments ranging from $17 to $162 639 815
Capital lease obligations 850 181
- --------------------------------------------------------------------------------
28,987 38,211
Less current maturities (16,687) (10,086)
- --------------------------------------------------------------------------------
$ 12,300 $ 28,125
================================================================================
At December 31, 1996, aggregate required payments of long-term debt, including
capitalized lease obligations, are as follows:
- --------------------------------------------------------------------------------
1997 $18,225
1998 7,819
1999 276
2000 160
2001 10
Thereafter 4,500
- --------------------------------------------------------------------------------
$30,990
================================================================================
11. MINORITY INTERESTS
In February 1996, the Company established Kobayashi Sofamor Danek K.K. ("KSD")
in Japan. The Company and Kobayashi Pharmaceutical Co., Ltd. ("KPC") each hold a
50% interest in KSD; however, the Company controls the financial and operational
direction of KSD. KSD sells the Company's products exclusively to KPC. During
1996, the Company made a $26,700 prepayment of commissions to KPC under a thirty
year agreement. The Company is amortizing the balance based upon sales to KPC.
At December 31, 1996, the Company has recorded an aggregate of $26,338 included
in prepaid expenses and other assets, which represents the unamortized portion
of the prepayment.
In November 1996, the Company established Danek Korea Co., Ltd. ("DK") in Korea.
The Company and Joint Medical Company ("JMC") each hold a 50% interest in DK;
however, the Company controls the financial and operational direction of DK. DK
sells the Company's products exclusively to JMC.
During 1996, in the aggregate, the Company recorded sales of $28,843 to KPC and
JMC. At December 31, 1996, the Company had total receivables, in the aggregate,
of $8,498 from KPC and JMC.
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40
12. INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31, is as
follows:
- ----------------------------------------------------------------------------------
U.S.
FEDERAL STATE FOREIGN TOTAL
- ----------------------------------------------------------------------------------
1996
Current $ 11,061 $ 1,387 $ 4,676 $ 17,124
Deferred (16,010) (2,837) 427 (18,420)
- ----------------------------------------------------------------------------------
(4,949) (1,450) 5,103 (1,296)
Charge in lieu of income taxes 2,240 349 -- 2,589
- ----------------------------------------------------------------------------------
$ (2,709) $ (1,101) $ 5,103 $ 1,293
==================================================================================
1995
Current $ 7,587 $ 805 $ 670 $ 9,062
Deferred (16,141) (171) (3) (16,315)
- ----------------------------------------------------------------------------------
(8,554) 634 667 (7,253)
Charge in lieu of income taxes 794 140 -- 934
- ----------------------------------------------------------------------------------
$ (7,760) $ 774 $ 667 $ (6,319)
==================================================================================
1994
Current $ 4,896 $ 627 $ 24 $ 5,547
Deferred (400) (14) 665 251
- ----------------------------------------------------------------------------------
4,496 613 689 5,798
Charge in lieu of income taxes 220 34 -- 254
- ----------------------------------------------------------------------------------
$ 4,716 $ 647 $ 689 $ 6,052
==================================================================================
Charges in lieu of income taxes were recorded by the Company as a result of
certain common stock options being exercised and the vesting of certain
restricted common stock.
An analysis of the net deferred income tax asset at December 31, is as follows:
- --------------------------------------------------------------------------------
1996 1995
- --------------------------------------------------------------------------------
Current deferred income tax assets:
Accounts receivable $ 356 $ 322
Inventory 3,680 3,720
Other 1,276 657
--------------------------------------------------------------------------------
Total current deferred income tax assets 5,312 4,699
- --------------------------------------------------------------------------------
Non-current deferred income tax assets:
Product liability litigation 17,500 --
License agreement 14,017 15,075
Other 1,485 191
- --------------------------------------------------------------------------------
Total non-current deferred income tax assets 33,002 15,266
- --------------------------------------------------------------------------------
Total deferred income tax assets $38,314 $19,965
================================================================================
Non-current deferred income tax liabilities:
Property, plant and equipment $ 121 $ 191
- --------------------------------------------------------------------------------
Total non-current deferred income tax liabilities $ 121 $ 191
================================================================================
No valuation allowance was recorded since sufficient taxable income exists in
available carryback periods to fully recognize these net deferred tax assets.
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41
A reconciliation of federal statutory and effective income tax rates is as
follows:
- --------------------------------------------------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------
Statutory U.S. federal income tax rate 35.0% 35.0% 35.0%
Effect of:
Foreign operations (12.3) 732.7 (8.0)
State income taxes, net of income tax benefit (7.3) (46.2) 1.3
Tax credits (2.0) 20.5 (2.9)
Inventory contribution (4.2) -- (1.4)
Other, net -- (66.2) (3.7)
- --------------------------------------------------------------------------------
Effective rate 9.2% 675.8% 20.3%
================================================================================
13. RELATED PARTY TRANSACTIONS
At December 31, 1995, the Company had loans of $4,165 to the Company's Chairman
and Chief Executive Officer ("Chairman") for the purchase of common stock of the
Company and for personal income taxes resulting from the exercise of common
stock options and the vesting of certain restricted stock. Interest was charged
at the applicable short-term federal rate as prescribed by the Internal Revenue
Service and was due annually. During 1996, the Company's Board of Directors
approved an amendment to the Chairman's loan forgiveness arrangements providing
for forgiveness of the loans and the related compensation expense in increments
beginning in 1996 through 2005 and for paying all future applicable taxes and
interest on the loans. This forgiveness is conditional upon the Chairman
remaining continuously employed by the Company for the next ten years and
certain performance criteria. In the event of a change in control of the
Company, the loans are immediately forgiven. The balance of the loans at
December 31, 1996 was approximately $3,715 and collateralized by 200,000 shares
of common stock.
14. COMMITMENTS AND CONTINGENCIES
The Company and its subsidiaries lease certain equipment and facilities under
non-cancelable operating leases expiring in 2001. The future annual minimum rent
payments under these leases at December 31, 1996 are as follows:
- --------------------------------------------------------------------------------
YEAR
- --------------------------------------------------------------------------------
1997 $2,110
1998 1,572
1999 1,314
2000 1,070
2001 77
- --------------------------------------------------------------------------------
$6,143
================================================================================
Rent expense for 1996, 1995, and 1994, including month-to-month leases, was
approximately $1,914, $903, and $711, respectively.
The Company has agreements with certain entities which provide the Company the
rights to manufacture and market certain spinal system products developed and
patented by these entities. The agreements provide for royalty payments ranging
from 1% to 10% of the net selling prices (as defined by the agreements) of all
the products sold or for required royalty payments, based on a predefined fee.
These agreements are in force as long as the Company sells the related products.
Royalty expense was $6,768, $5,907, and $4,083 in 1996, 1995, and 1994,
respectively.
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42
At December 31, 1996, the Internal Revenue Service was conducting an audit of
the Company's federal tax returns for the fiscal years ended December 31, 1995
and 1994. The Company is unable at this time to make a determination as to the
ultimate outcome or the financial impact of these audits.
15. LITIGATION
The Company is involved from time to time in litigation on various matters which
are routine to the conduct of this business, including product liability and
intellectual property cases.
PRODUCT LIABILITY CASES
Multidistrict Litigation:
In 1994, the Company and other spinal implant manufacturers were named as
defendants in purported class action product liability lawsuits in various
federal courts throughout the country alleging that plaintiffs were injured by
spinal implants manufactured by the Company and others. On August 4, 1994, the
Federal Judicial Panel on Multidistrict Litigation ordered that all federal
court lawsuits then existing be transferred to and consolidated for pretrial
proceedings, including the determination of class certification, in the United
States District Court for the Eastern District of Pennsylvania in Philadelphia
(the "Multidistrict Litigation"). Federal court lawsuits filed after August 4,
1994 have also been transferred to and consolidated in the Eastern District of
Pennsylvania. On February 22, 1995, Chief Judge Emeritus Louis C. Bechtle denied
class certification. The federal court lawsuits before Judge Bechtle will remain
coordinated for further pretrial purposes but are individual lawsuits. As
previously disclosed, as a result of the denial of class certification by Judge
Bechtle, a large number of additional plaintiffs have filed lawsuits alleging
injuries caused by spinal implants manufactured by the Company. To date,
approximately two thousand eight hundred (2,800) plaintiffs have filed lawsuits
against the Company, with a few also naming as defendants various officers and
directors of the Company. A majority of these plaintiffs filed their claims in
1995. Also, plaintiffs' lawyers have filed lawsuits involving about two thousand
eight hundred fifty (2,850) claimants alleging a conspiracy theory among
doctors, manufacturers (including the Company), hospitals, teaching
institutions, professional societies and others to promote, in violation of
applicable law, the use of spinal implants. Some plaintiffs have filed
individual lawsuits, whereas other lawsuits list multiple plaintiffs and, in
certain instances, multiple lawsuits have been filed on behalf of the same
individual plaintiffs. On August 22, 1996, Judge Bechtle dismissed without
prejudice plaintiffs' conspiracy claims. Many plaintiffs asserting these
conspiracy claims have filed amended or new complaints, but it is not possible
at this time to determine precisely how many of these conspiracy complaints will
be reasserted or the number of additional plaintiffs that may file lawsuits.
The majority of such lawsuits were filed in federal courts throughout the
country and are in the preliminary stages. Discovery proceedings, including the
taking of depositions, have been ongoing in certain of the lawsuits that were
first to be filed. Discovery in certain cases that were filed later will begin
in 1997. Over one thousand eight hundred (1,800) of the plaintiffs have had
their lawsuits returned to the state court in Memphis, Tennessee because it was
determined that the federal courts lacked jurisdiction over their claims. It is
anticipated that the Memphis, Tennessee state court judge will establish a
schedule for case management and discovery. The trials of a number of lawsuits
involving individual plaintiffs are scheduled to begin in the first six months
of 1997, although delays in trial dates are common. Although plaintiffs have
advanced claims under many different legal theories, the essence of plaintiffs'
claims appears to be that the Company (including Sofamor and its former U.S.
distributor) marketed some of its spinal systems for pedicle fixation in
contravention of FDA rules and regulations (governing marketing and labeling),
that pedicle fixation has not been proven safe and efficacious in the context of
FDA labeling standards and that plaintiffs have suffered a variety of injuries
as a result of the use of the systems for pedicle fixation. Plaintiffs in these
cases typically seek relief in the form of monetary damages, often in
unspecified amounts. Many of the plaintiffs only allege as monetary damages an
amount in excess of the jurisdictional minimum for the courts in which such
cases are filed.
In December 1996, AcroMed Corporation ("AcroMed"), a spinal implant manufacturer
and a defendant in various of the cases pending in the Multidistrict Litigation,
and the Plaintiffs' Legal Committee in the Multidistrict Litigation announced
that they have entered into an understanding to resolve all product liability
claims involving
39
43
the use of AcroMed devices to achieve pedicular fixation in spinal fusion
surgery. Under the announced terms of the proposed settlement, AcroMed will
establish a settlement fund consisting of $100 million in cash and the proceeds
of its product liability insurance policies. The parties submitted in January
1997 a formal class settlement agreement and related documentation for approval
by Judge Bechtle. A hearing (scheduled for April 23, 1997) will be held to
consider the fairness, adequacy and reasonableness of the settlement. All
federal court proceedings involving AcroMed devices have been stayed pending
final consideration of the proposed settlement.
Tennessee and Oregon Product Liability Actions:
In January 1995, the Company and other spinal implant manufacturers, doctors and
a hospital were named defendants in a purported class action product liability
lawsuit filed in Nashville, Tennessee state court. This lawsuit is limited to
those individuals whose surgeries were performed at one specific hospital. Class
certification has been denied by the trial judge in Nashville. The judge has
selected two of the Company's cases as test cases to be prepared for trial. Fact
discovery in these cases is scheduled for completion by March 1997. All other
proceedings are stayed. In October 1995, the Company was served with a Portland,
Oregon state court complaint that purported to be a class action. This Oregon
complaint alleged, among other things, injury based upon various legal theories.
In March 1996, the plaintiffs in this Oregon case withdrew the class
allegations. Discovery has begun in these individual cases. In these Tennessee
and Oregon actions, plaintiffs, who seek relief in the form of monetary damages
of unspecified amounts, are continuing their lawsuits as individual cases.
The Company believes that it has defenses, including, without limitation,
defenses based upon the failure of a cause of action to exist where no
malfunction of the implant has occurred or the plaintiff has suffered no injury
attributable to the Company's product, the expiration of the applicable statute
of limitations and the learned intermediary defense. The Company has and will
continue to assert the defenses primarily through the filing of dispositive
motions. The Company believes that all product liability lawsuits currently
pending against it are without merit and will continue to defend them
vigorously.
All pending cases are currently being defended by insurance carriers, generally
under reservation of rights. To date the cost of defending against claims has
been largely reimbursed by the Company's insurers. The Company's insurance
policies are reduced by the costs of defense, except for a policy issued by
Royal Surplus Lines Insurance Co. ("Royal") covering the 12-month period that
began in November 1995 (see below). The Company estimates that the litigation
may continue for several years and, if so, the cost to defend and conclude these
lawsuits is likely to exhaust its insurance coverage. An insurer, Royal,
providing coverage for the 12-month period commencing in November 1995, brought
an action in early December 1996 in the Federal District Court for the Middle
District of Tennessee (Nashville Division) seeking a declaratory judgment as to,
among other things, whether the policy covers lawsuits which have been reported
to the insurer during the policy period. At December 31, 1996, the Company had a
receivable from Royal of approximately $2.5 million for legal fees associated
with the Company's product liability litigation paid by the Company during the
policy year. The Company believes that the receivable is recoverable under the
terms of the policy. The case is in a preliminary stage. Discovery has just been
initiated. The Company believes the suit is without merit and will defend it
vigorously.
As is common in the insurance industry, the Company's insurance policies
covering product liability claims must be renewed annually. Although the Company
has been able to obtain insurance coverage relating to product liability claims
at a cost and on other terms and conditions that are acceptable to the Company,
there can be no assurance that in the future it will be able to do so.
On January 6, 1997, the Company announced that its 1996 financial results would
include a pre-tax charge of $50 million relating to costs associated with the
product liability litigation described above. The charge, which has now been
reflected in the Company's 1996 financial statements, covers the reasonably
foreseeable costs that the Company was positioned in late December to estimate
because the litigation had progressed and because changes in the fourth quarter
of 1996 had occurred in facts and circumstances relating to the litigation.
Among the changed facts and circumstances were the announcement of the AcroMed
proposed settlement described above, the additional financial resources
available to the plaintiffs' attorneys as a result of the settlement if the
proposed settlement is ultimately approved, the likelihood that the litigation
will continue for several years, in part, due to the
40
44
additional financial resources provided to plaintiffs' attorneys if the proposed
settlement is approved, the absence of AcroMed as a member of the joint defense
group, the status of the Company's insurance described above and the continuing
absence of dispositive rulings relating to the Company's defense motions.
While it is not possible to accurately predict the outcome of litigation, the
amount of the charge taken in the fourth quarter represents the Company's best
judgment of the probable reasonable costs (in excess of available insurance) to
defend and conclude the lawsuits based on the facts and circumstances currently
existing. The costs provided for include, but are not limited to, legal fees
paid or anticipated to be paid and other costs related to the Company's defense
and conclusion of these matters.
The actual costs to the Company could differ from the estimated charge and will
be dependent upon a number of factors that will not be known for some time,
including, among other things, the resolution of defense motions and the extent
of further discovery. Although an adverse resolution of the lawsuits could have
a material effect on the Company's results of operations in future periods, the
Company does not believe that these matters will in the future have a material
adverse effect on its consolidated financial position. The Company is unable to
predict the ultimate outcome or the financial impact of the product liability
litigation.
SECURITIES LAWS ACTIONS
Beginning in April 1994, the Company and four of its officers and directors were
named in five shareholder lawsuits filed in the United States District Court in
Memphis, Tennessee. Four of the lawsuits purport to be class actions. All of the
lawsuits were consolidated into one case in the United States District Court in
Memphis through an amended complaint which added four new individual defendants
who are either current or former directors of the Company. The lawsuit alleges
that the defendants made false and misleading statements and failed to disclose
material facts to the investing public and seeks money damages. The alleged
securities law violations are based on the claim that the defendants failed to
disclose that the Company sold its products illicitly, illegitimately and
improperly and to timely disclose facts concerning the termination of the former
United States distributor of Sofamor products, National Medical Specialties,
Inc. ("NMS"). The allegations relating to illicit and illegitimate sales of
product are, for the most part, copied from product liability complaints filed
against the Company and other manufacturers currently being coordinated in the
United States District Court for the Eastern District of Pennsylvania which are
referred to above. The allegations of improper sales relate to one of the
Company's selling programs which has been publicly disclosed since May 1991. The
allegations concerning NMS relate to the termination of the NMS distribution
agreement covering Sofamor products in the United States. On October 3, 1995,
the United States District Court Judge in Memphis dismissed with prejudice the
entire case against the Company and each of the individual defendants. The
plaintiffs have appealed the dismissal to the United States Court of Appeals for
the Sixth Circuit, which has not yet ruled on this appeal.
SPANISH DISTRIBUTOR ACTION
In late September 1994, a Magistrate of the Commercial Court in Paris ruled in
favor of a former Spanish distributor of Sofamor's products on a claim of
wrongful termination of the distribution agreement in 1992. Prior to the
Combination, an accrual was established, with a related charge to earnings, for
this pending litigation. On the Combination date in June 1993, the Company also
established a separate indemnity with respect to potential losses resulting from
such lawsuit and placed in escrow shares issued to the former Sofamor
shareholders pending the final outcome of this lawsuit. The $3.0 million award
(including interest) rendered by the French Magistrate exceeded the
pre-established accrual. As a result, the Company recorded an expense of $2.2
million for the non-recurring litigation award during the third and fourth
quarters of 1994. The Company filed an appeal which involves a complete retrial
on all issues. The former Spanish distributor recently filed its papers in the
appeal and seeks additional damages; the Company seeks to have the decision of
the Commercial Court reversed. A hearing on the appeal is currently scheduled
for the fourth quarter of 1997.
The Company does not believe the Securities Laws Actions or the Spanish
Distributor Action, described above, will have a material adverse effect on its
consolidated financial position, results of operations or cash flows because of,
among other reasons, the facts and circumstances existing with respect to each
action, the Company's belief that
41
45
these actions are without merit, certain defenses available to the Company and
the availability of insurance in the Securities Laws Actions.
16. STOCK OPTION AND RESTRICTED STOCK PLANS
In 1990, the Company adopted an incentive stock option plan (the "1990 Plan")
for certain key employees, covering 1,475,000 shares of common stock, a
non-qualified stock option plan for distributors and consultants (the
"Distributor and Consultant Plan") covering 225,000 shares of common stock, and
a restricted stock plan covering 148,450 shares of common stock. The number of
shares covered under the 1990 Plan was subsequently reduced to 675,000 on June
21, 1993.
Under the Distributor and Consultant Plan, the exercise price may not be less
than $2.22 per share. Options have a maximum term of ten years from the date of
the option grant. During 1995, the number of shares of common stock covered was
increased to 625,000.
In February 1991, the Company adopted a stock option plan for certain directors
of the Company (the "Directors' Plan").
In December 1992, the Company adopted the 1993 long-term incentive plan (the
"Long-Term Incentive Plan") for certain directors and key employees, covering
500,000 shares of common stock. The number of shares of common stock reserved
under the Long-Term Incentive Plan was increased to 800,000 in 1993, to
2,500,000 in 1994 and to 3,500,000 in 1995. Awards may be in the form of stock
options to purchase shares, stock appreciation rights, performance units,
restricted stock or any combination of the above. Options have a maximum term of
ten years from the date of the option grant. Under the Long-Term Incentive Plan,
the exercise price shall be determined by the Company, except that the exercise
price may not be less than the market price at the date of the option grant for
any incentive stock options awarded.
During 1996, the Board of Directors proposed an amendment to the Company's
Long-Term Incentive Plan to increase the number of shares of the common stock
available under the Plan by 2,500,000, contingent upon approval by the Company's
shareholders. Also, the Board of Directors proposed an amendment to the
Company's Incentive Stock Option Plan to decrease the number of shares of the
common stock available under the Plan by 61,642.
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46
Activity under all of the stock option plans, including the 2,500,000 shares of
common stock approved by the Board of Directors in 1996, for the years ended
December 31, 1996, 1995, and 1994 is summarized as follows:
- --------------------------------------------------------------------------------------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
Shares under option at beginning of year 3,597,939 2,661,120 808,648
Granted 1,621,150 1,453,700 2,511,000
Exercised (417,744) (231,653) (54,062)
Lapsed (37,873) (285,228) (70,766)
Terminated (468,100) - (533,700)
-------------------------------------------------------------------------------------------------------------------
Shares under option at end of year 4,295,372 3,597,939 2,661,120
====================================================================================================================
Shares under option exercisable at end of year 1,175,832 863,739 480,740
Price range of shares under option excercisable at end
of year $3.87 - $37.50 $3.87 - $37.50 $3.87 - $37.50
Weighted average exercise price $16.17 $14.75 $12.45
Shares available for future grant 2,057,068 733,887 502,359
====================================================================================================================
Additional information regarding stock options outstanding at December 31, 1996
is shown below:
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
- --------------------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE REMAINING TERM EXERCISE
OPTION PRICE RANGE OPTION SHARES PRICE OPTION SHARES PRICE
- --------------------------------------------------------------------------------------------------------
$ 3.50 - $14.50 1,625,880 $12.57 8.8 years 719,976 $12.17
$14.51 - $24.50 1,709,342 $20.05 8.4 years 318,056 $19.76
$24.51 - $37.50 960,150 $27.12 9.1 years 137,800 $28.73
The Company applies APB Opinion No. 25 and related Interpretations in accounting
for its plans. SFAS 123, "Accounting for Stock-Based Compensations ("SFAS 123")
was issued during 1995 and changes the methods for recognition of cost on plans
similar to those of the Company. Adoption of the accounting provisions of SFAS
123 is optional; however, pro forma disclosures as if the Company adopted the
cost recognition requirements under SFAS 123 is presented below:
- --------------------------------------------------------------------------------
1996 1995
- --------------------------------------------------------------------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA
- --------------------------------------------------------------------------------
Net income $11,267 $8,726 $4,967 $4,063
Net income per share $ 0.44 $ 0.34 $ 0.20 $ 0.16
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1996: dividend yield of 0%, expected volatility
of 44.4%, risk-free interest rate of 6.2%, and expected lives of 4.2 years;
1995: dividend yield of 0%, expected volatility of 44.4%, risk-free interest
rate of 6.3%, and expected lives of 4.2 years. The weighted average fair value
of options at grant date were $12.59 and $8.20 in 1996 and 1995, respectively.
43
47
The effects of applying SFAS 123 in this pro forma disclosure are not indicative
of future amounts.
SFAS 123 does not apply to awards prior to 1995, and additional awards in future
years are anticipated.
17. NET INCOME PER COMMON SHARE
Primary and fully diluted net income per common share are computed by dividing
net income by the weighted average number of common shares and common share
equivalents outstanding during the period. Common stock equivalents are in the
form of stock options which have an effect on 1996, 1995 and 1994 primary and
fully diluted net income per common share calculations. Common stock equivalents
for 1996 and 1995 also include assumed converted debt securities. For the years
ended December 31, 1996 and 1995, net income was adjusted by $124 and $115,
respectively, to calculate earnings per share. This adjustment represented the
interest charges, net of taxes, incurred in relation to convertible debt which
was assumed to be converted for the weighted average number of shares
calculation. Share equivalents used for fully diluted calculations in 1996, 1995
and 1994 are higher than share equivalents used for primary net income per share
calculations due to the higher fair value of the common stock at the year end
versus the average fair value of the stock during the year. The following table
presents information necessary to calculate net income per share for the fiscal
years ended December 31, 1996, 1995 and 1994:
- -----------------------------------------------------------------------------------------------------------
1996 1995 1994
- -----------------------------------------------------------------------------------------------------------
Primary:
Weighted average shares outstanding 24,284,005 23,846,242 24,013,855
- -----------------------------------------------------------------------------------------------------------
Shares equivalents 1,762,442 1,369,363 482,852
26,046,447 25,215,605 24,496,707
===========================================================================================================
Fully diluted:
Weighted average shares outstanding 24,284,005 23,846,242 24,013,855
Shares equivalents 1,824,548 1,548,519 568,220
- -----------------------------------------------------------------------------------------------------------
26,108,553 25,394,761 24,582,075
============================================================================================================
18. ACCRUED EXPENSES
Accrued expenses at December 31, 1996 and 1995 consist of the following:
- --------------------------------------------------------------------------------------------------------
1996 1995
- --------------------------------------------------------------------------------------------------------
Amounts due to suppliers $ 2,045 $ 2,778
Commissions 5,001 3,420
Payroll, benefits, and related taxes 12,493 3,848
Royalties 2,288 1,452
Amount due to former shareholders of acquired company 4,174 -
Interest 1,018 1,879
Product liability litigation 2,000 -
Other 9,751 7,757
- --------------------------------------------------------------------------------------------------------
$ 38,770 $ 21,134
=========================================================================================================
19. EMPLOYEE BENEFIT PLANS
In January 1990, the Company adopted an employee savings plan under Section
401(k) of the Internal Revenue Code. This plan covers all employees that are 21
years of age and have completed at least six months of continuous service with
the Company. In 1994, the Company's allowable match was 50% of the employees'
contributions up to a maximum of 4% of the payroll of each participant. In 1995,
the Company increased its maximum matching contribution to equal 100% of the
employee's first 3% contributed and 50% of the next 2%. These matching
percentages are subject to revision at the discretion of the Company's Board of
Directors. Company contributions generally vest at 20% per year beginning the
end of the second year of service with the participants becoming fully
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48
vested in the sixth year of service. The amount charged against income in 1996,
1995, and 1994 was approximately $477, $385, and $172, respectively.
In November 1991, the Company adopted an employee stock purchase plan ("ESPP")
to provide employees of the Company the opportunity to purchase shares of common
stock of the Company. The ESPP covers full-time employees of the Company (as
defined by the ESPP) that have completed 6 months of employment. An aggregate of
60,000 of the Company's shares of common stock have been reserved for inclusion
in the ESPP. The amount charged against income in 1996, 1995, and 1994 was
approximately $22, $14, and $19, respectively, which represented the Company's
contribution of 15% of the employee's contribution.
20. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount for cash, short-term investments, notes and other
receivables, and notes and loans payable approximates fair value due to the
short maturity of these instruments.
The fair value of the Company's long-term debt is estimated based on current
rates offered to the Company for debt of the same remaining maturities or quoted
market prices for the shares of stock to which the debt instrument may be
converted, as applicable.
The estimated fair value of the Company's financial instruments at December 31,
1996 are as follows:
- --------------------------------------------------------------------------------
CARRYING AMOUNT FAIR VALUE
- --------------------------------------------------------------------------------
Cash and short-term investments $ 2,830 $ 2,830
Short-term investments 111 111
Other receivables 15,813 15,813
Notes payable and lines of credit 50,207 50,207
Long-term debt 28,987 30,778
- --------------------------------------------------------------------------------
$ 97,948 $ 99,739
================================================================================
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information set forth under the caption "Election of Directors" contained on
pages 2 and 3 of the Company's definitive Proxy Statement for its 1997 Annual
Meeting of Shareholders (the "1997 Proxy Statement") is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under the captions "Executive Compensation" contained
on pages 8 and 9 of the Company's 1997 Proxy Statement is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth under the caption "Common Stock Owned by Principal
Shareholders and Management" contained on pages 6 and 7 of the Company's 1997
Proxy Statement is incorporated herein by reference.
45
49
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth under the caption "Certain Relationships and Related
Transactions" contained on pages 16 and 17 of the Company's 1997 Proxy Statement
is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) DOCUMENTS FILED AS PART OF THIS REPORT
(1) Financial Statements
Report of Independent Public Accountants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Consolidated Balance Sheets--December 31, 1995 and 1994 . . . . . . . . . . . . . . . . . . . . . . . 25
Consolidated Statements of Income--Years ended December 31, 1995, 1994 and 1993 . . . . . . . . . . . . 26
Consolidated Statements of Changes in Stockholders' Equity--Years ended
December 31, 1995, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Consolidated Statements of Cash Flows--Years ended December 31, 1995, 1994 and 1993 . . . . . . . . . . 28
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
(2) Financial Statement Schedules
Report of Independent Accountants on Financial Statement Schedules . . . . . . . . . . . . . . . . . . 48
Schedule VIII--Valuation and Qualifying Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
Schedules other than those referred to above have been omitted because they are
not required or because the information is included elsewhere in the
Consolidated Financial Statements.
(3) Exhibits
See Index to Exhibits
(B) REPORTS ON FORM 8-K
None
46
50
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.
SOFAMOR DANEK GROUP, INC.
(REGISTRANT)
BY: /s/ E. R. PICKARD
--------------------------------------
E. R. PICKARD
CHAIRMAN, CHIEF EXECUTIVE
OFFICER AND DIRECTOR
MARCH 21, 1997
-------------------------------------
DATE
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
- --------- ---------------- ----
/s/ E. R. Pickard Chairman, Chief Executive Officer and March 21, 1997
- --------------------------- Director (Principal Executive Officer)
E. R. Pickard
/s/ Laurence Y. Fairey Chief Financial Officer and Executive Vice March 21, 1997
- --------------------------- President (Principal Financial and
Laurence Y. Fairey Accounting Officer)
L. D. Beard* Director March 21, 1997
- ---------------------------
L. D. Beard
George W. Bryan, Sr.* Director March 21, 1997
- ---------------------------
George W. Bryan, Sr.
Robert A. Compton* Director March 21, 1997
- ---------------------------
Robert A. Compton
Yves Paul Cotrel, M.D.* Director March 21, 1997
- ---------------------------
Yves Paul Cotrel, M.D.
/s/ James J. Gallogly Director, President and March 21, 1997
- --------------------------- Chief Operating Officer
James J. Gallogly
Samuel F. Hulbert, Ph.D.* Director March 21, 1997
- ---------------------------
Samuel F. Hulbert, Ph.D.
Marie-Helene Plais, M.D.* Director March 21, 1997
- ---------------------------
Marie-Helene Plais, M.D.
George F. Rapp, M.D.* Director March 21, 1997
- ---------------------------
George F. Rapp, M.D.
*By: /s/ J. Mark Merrill
---------------------
J. Mark Merrill
Attorney-in-Fact
47
51
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
Our report on the consolidated financial statements of Sofamor Danek Group, Inc.
and Subsidiaries is included on page 24 of this Form 10-K. In connection with
our audits of such consolidated financial statements, we have also audited the
related consolidated financial statement schedule in the index on page 46 of
this Form 10-K.
In our opinion, the consolidated financial statement schedule referred to above,
when considered in relation to the basic consolidated financial statements taken
as a whole, presents fairly, in all material respects, the information required
to be included therein.
COOPERS & LYBRAND, L.L.P.
Memphis, Tennessee
January 31, 1997
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52
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
Balance at Charged to Balance at
beginning of costs and Deductions and end of
Description period expenses Reclassifications Other(2) period
- -----------------------------------------------------------------------------------------------------------------------------
Allowance for doubtful accounts
For the Years Ended December 31,
--------------------------------
1996 $1,555 $705 $(698) (1) $ 27 $1,589
1995 1,654 318 (704) (1) 287 1,555
1994 1,074 966 (377) (1) (9) 1,654
(1) Amounts written off during the year
(2) Foreign currency translation adjustment
49
53
SOFAMOR DANEK GROUP, INC.
ANNUAL REPORT ON FORM 10-K
DECEMBER 31, 1996
INDEX TO EXHIBITS
Number Assigned
in Regulation
S-K, Item 601 Description of Exhibit
- -------------- ----------------------
(3) 3.1 Amended and Restated Articles of Incorporation of Sofamor
Danek Group, Inc. (the "Company") (1) (3.1), as further
amended by Articles of Amendment dated June 22, 1993 (6) (3.1)
3.2 * Amended and Restated Code of By-Laws of the Company
(4) 4.1 Form of Certificate for Common Stock (6) (4.1)
(10) 10.1 Agreement by and between Danek Medical, Inc. and Texas
Scottish Rite Hospital for Crippled Children, dated
August 9, 1988, as amended by a letter agreement dated
August 21, 1991, amending the schedule to the Agreement
(3) (10.17)
10.2 Agreement by and between AcroMed Corporation and Danek
Medical, Inc., dated March 29, 1989, as amended (2) (10.18)
10.3 Agreement for Sublease by and between Word, Inc. and the
Company, dated February 29, 1988 (2) (10.24)
10.4 * $40,000,000 Revolving Line of Credit Loan Agreement with
Third National Bank in Nashville dated October 14, 1994,
(the "Revolving Loan Agreement") as amended by
* Amendment to Revolving Loan Agreement dated June 30, 1995,
* Second Amendment to Revolving Loan Agreement dated October 11,
1995,
* Third Amendment to Revolving Loan Agreement dated August 1, 1996, and
* Fourth Amendment to Revolving Loan Agreement dated January 31, 1997.
10.5 Stock Exchange Agreement, dated as of March 28, 1993, among
the Company and the Holders listed on the signatory pages
thereto of all of the issued and outstanding shares of capital
stock of Sofamor, S.A. (4) (2.1)
10.6 Amendment No. 1 to the Stock Exchange Agreement, dated as of
June 21, 1993, among the Company and the Holders of all of the
capital stock of Sofamor, S.A. (5)
10.7 Shareholders' Agreement among the Company, the shareholders
listed on the signatory pages thereto and SOFYC, S.C., as the
Designated Representative of such shareholders (4) (10.1)
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54
Number Assigned
in Regulation
S-K, Item 601 Description of Exhibit
- -------------- ----------------------
10.8 Escrow Agreement among the Company, the Holders listed on
the signatory pages thereof of all of the issued and outstanding
capital stock of Sofamor, S.A. and Citibank, N.A. as escrow
agent dated June 21, 1993 (4) (10.2)
10.9 Intellectual Property Purchase Agreement, dated as of March 28,
1993, among the Company, Dr. Yves Paul Cotrel and Sofamor, S.A. (4) (10.3)
10.10 Amended and Restated License Agreement between Genetics Institute, Inc.
and Sofamor Danek Properties, Inc. dated February 15, 1995 (8) (10.1)
MANAGEMENT CONTRACTS, COMPENSATORY PLANS OR ARRANGEMENTS, ETC.
10.11 Employment Agreement and Letter Agreement between Richard E. Duerr, Jr.
and the Company dated January 1, 1996 (9) (10.15)
10.12 Employment Agreement and Letter Agreement between Laurence Y. Fairey and
the Company dated January 1, 1996 (9) (10.16)
10.13 Employment Agreement and Letter Agreement between Mark D. LoGuidice and
the Company dated January 1, 1996 (9) (10.17)
10.14 Employment Agreement and Letter Agreement between J. Mark Merrill and
the Company dated January 1, 1996 (9) (10.18)
10.15 * Employment Agreement between Peter J. Elkhuizen and the Company dated
October 30, 1996.
10.16 Employment Agreement and Letter Agreement between Richard W. Treharne and
the Company dated January 1, 1996 (9) (10.20)
10.17 Employment Agreement and Letter Agreement between Don W. Urbanowicz and
the Company dated January 1, 1996 (9) (10.21)
10.18 Employment Agreement between R. Lew Bennett and the Company dated
January 1, 1996 (9) (10.22)
10.19 Employment Agreement between Gene B. Sponseller and the Company dated
January 1, 1996 (9) (10.24)
10.20 Letter Agreement between E. R. Pickard and the Company dated January 1, 1996
and Resolution of the Company's Compensation Committee (9) (10.25)
10.21 Letter Agreement between James J. Gallogly and the Company dated January 1, 1996
and Resolution of the Company's Compensation Committee (9) (10.26)
10.22 Employment Agreement between Sofamor and Marie-Helene
Plais dated June 21, 1993 (6) (10.50)
ii
55
Number Assigned
in Regulation
S-K, Item 601 Description of Exhibit
- -------------- ---------------------- -
10.23 Amended and Restated Non-Qualified Stock Option Plan (2) (10.25)
10.24 Non-Qualified Stock Option Agreement between the Company
and E. R. Pickard dated November 30, 1990, (2) (10.26)
as amended by an Amendment dated March 10, 1992 (3) (10.26)
and by Second Amendment dated February 16, 1995 (7) (10.24)
and by Third Amendment dated July 21, 1995 (9) (10.28)
10.25 Incentive Stock Option Plan, as amended (1) (10.30)
10.26 Amended and Restated Stock Option Plan for Distributors and
Consultants (9) (10.30)
10.27 Non-Employee Directors' Stock Option Plan (2) (10.34)
10.28 * Cash Bonus Plan
10.29 * Employee Stock Purchase Plan
10.30 * Amended and Restated Loan Forgiveness Agreement dated
October 11, 1996 between the Company and E.R. Pickard.
10.31 * 1993 Long-Term Incentive Plan, as amended
10.32 Stock Pledge Agreement between E. R. Pickard and the
Company dated November 30, 1990. (6) (10.42)
10.33 Agreement between the Company and E. R. Pickard dated
December 15, 1995 (9) (10.40)
(22) 22.1 * Subsidiaries of the Company
(24) 24.1 * Consent of Coopers & Lybrand, Independent Public Accountants
(25) 25.1 * Powers of attorney from directors of the Company
authorizing signature of this report
(27) 27.1 * Financial Data Schedule (For SEC use only)
(28) 28.1 * Annual Report on Form 11-K of the Employee Stock
Purchase Plan for the fiscal year ended December
31, 1996
- ----------------------
* Previously unfiled documents are noted with an asterisk
iii
56
(1) Incorporated by reference from the Exhibits to the Form 10-K of the
Registrant for the fiscal year ended December 31, 1992. (Exhibit number in
the Form 10-K is set forth in italics.)
(2) Incorporated by reference from the Exhibits to the Form S-1 Registration
Statement No. 33-39593 of the Registrant. (Exhibit number in the Form S-1
is set forth in italics.)
(3) Incorporated by reference from the Exhibits to the Form 10-K of the
Registrant for the fiscal year ended December 31, 1991. (Exhibit number in
the Form 10-K is set forth in italics.)
(4) Incorporated by reference from the Exhibits to the Form S-4 Registration
Statement No. 33-63040 of the Registrant. (Exhibit number in the Form S-4
is set forth in italics)
(5) Incorporated by reference from the Exhibits to the Form 8-K of the
Registrant filed with the Securities and Exchange Commission on June 29,
1993.
(6) Incorporated by reference from the Exhibits to the Form 10-K of the
Registrant for the fiscal year ended December 31, 1993. (Exhibit number in
the Form 10-K is set forth in italics.)
(7) Incorporated by reference from the Exhibits to the Form 10-K of the
Registrant for the fiscal year ended December 31, 1994. (Exhibit number in
the Form 10-K is set forth in italics.)
(8) Incorporated by reference from the Exhibits to the Form 10-Q of the
Registrant for the quarter ended March 31, 1995. (Exhibit number in the Form
10-K is set forth in italics.)
(9) Incorporated by reference from the Exhibits to the Form 10-K of the
Registrant for the fiscal year ended December 31, 1995. (Exhibit number in
the Form 10-K is set forth in italics.)
iv