1
Exhibit 99.1
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, 1997 and 1996, 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, 1997. 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, 1997 and 1996, and the
results of their consolidated operations and their cash flows for each of the
three years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Memphis, Tennessee
February 2, 1998
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CONSOLIDATED BALANCE SHEETS
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
(in thousands, except shares)
December 31,
- -------------------------------------------------------------------------------------------
1997 1996
- -------------------------------------------------------------------------------------------
ASSETS
- -------------------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents $ 2,729 $ 2,830
Short-term investments 36 111
Accounts receivable -- trade, less allowance for
doubtful accounts of $1,812 and $1,589 at
December 31, 1997 and 1996, respectively 88,209 70,031
Other receivables 29,374 15,813
Inventories 40,575 33,483
Loaner set inventories 21,511 14,123
Prepaid expenses 6,061 6,318
Prepaid income taxes 3,052 --
Current deferred income taxes 8,013 5,312
- -------------------------------------------------------------------------------------------
Total current assets 199,560 148,021
Property, plant and equipment
Land 1,477 1,484
Buildings 10,905 11,261
Machinery and equipment 35,677 32,083
Automobiles 759 708
- -------------------------------------------------------------------------------------------
48,818 45,536
Less accumulated depreciation (23,797) (20,026)
- -------------------------------------------------------------------------------------------
25,021 25,510
Investments 954 920
Intangible assets, net 97,048 83,426
Other assets 31,649 28,282
Non-current deferred income taxes 31,425 33,002
- -------------------------------------------------------------------------------------------
Total assets $ 385,657 $ 319,161
- -------------------------------------------------------------------------------------------
LIABILITIES
Current liabilities:
Notes payable and lines of credit $ 11,731 $ 50,207
Current maturities of long-term debt 7,586 16,687
Accounts payable 4,684 7,332
Income taxes payable 2,473 3,898
Accrued expenses 50,094 38,770
- -------------------------------------------------------------------------------------------
Total current liabilities 76,568 116,894
Long-term debt, less current maturities 60,650 12,300
Deferred income taxes -- 121
Product liability litigation, less current portion 33,970 48,000
Minority interest 3,171 2,020
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; 25,867,749 and 25,094,277 shares issued
(including 685,908 shares held in treasury
at December 31, 1997 and 1996, respectively) 74,014 52,994
Retained earnings 154,828 98,044
Cumulative translation adjustment (4,294) 2,542
- -------------------------------------------------------------------------------------------
224,548 153,580
Less:
Cost of common stock held in treasury (9,985) (9,985)
Unearned compensation -- (54)
Stockholder notes receivable (3,265) (3,715)
- -------------------------------------------------------------------------------------------
Total stockholders' equity 211,298 139,826
- -------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 385,657 $ 319,161
- -------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated
financial statements.
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CONSOLIDATED STATEMENTS OF INCOME
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
(in thousands, except per share data)
for the years ended December 31,
- ------------------------------------------------------------------------------------------------------------------
1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------
Revenues $ 312,902 $ 244,525 $ 188,799
Cost of goods sold 58,068 45,005 40,309
- ------------------------------------------------------------------------------------------------------------------
Gross profit 254,834 199,520 148,490
Operating expenses:
Selling, general and administrative 145,414 116,729 89,847
Research and development 19,747 15,926 13,980
License agreement acquisition charge -- -- 45,337
Product liability litigation charge -- 50,000 --
- ------------------------------------------------------------------------------------------------------------------
Total operating expenses 165,161 182,655 149,164
- ------------------------------------------------------------------------------------------------------------------
Income (loss) from operations 89,673 16,865 (674)
Other income 5 913 2,533
Interest expense (5,539) (3,744) (2,794)
- ------------------------------------------------------------------------------------------------------------------
Income (loss) before provision (benefit) for and charge in
lieu of income taxes and minority interest 84,139 14,034 (935)
Provision (benefit) for and charge in lieu of income taxes 25,073 1,293 (6,319)
- ------------------------------------------------------------------------------------------------------------------
Income before minority interest 59,066 12,741 5,384
Minority interest (2,282) (1,474) (417)
- ------------------------------------------------------------------------------------------------------------------
Net income $ 56,784 $ 11,267 $ 4,967
Net income per share - diluted $ 2.12 $ 0.44 $ 0.20
Net income per share - basic $ 2.29 $ 0.46 $ 0.21
- ------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated
financial statements.
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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
(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, 1995 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 & 934 934
stock options exercised
Unearned compensation
amortization 299 299
Stockholders' notes 26 26
receivable
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 & 2,588 2,588
stock options exercised
Unearned compensation
amortization 267 267
Stockholders' notes 450 450
receivable
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
Common stock issued 10,000 593 593
Exercise of stock options 763,472 13,103 13,103
Income tax benefit from
vesting of restricted stock & 7,324 7,324
stock options exercised
Unearned compensation
amortization 54 54
Stockholders' notes 450 450
receivable
Net income 56,784 56,784
Cumulative translation
adjustment (6,836) (6,836)
- ----------------------------------------------------------------------------------------------------------------------------------
Balances, December 31, 1997 25,181,841 $74,014 $154,828 $(4,294) $(9,985) -- $(3,265) $211,298
==================================================================================================================================
The accompanying notes are an integral part of the consolidated
financial statements.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
(in thousands)
for the years ended December 31,
- ----------------------------------------------------------------------------------------------------------------
1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 56,784 $ 11,267 $ 4,967
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 16,629 10,374 7,857
Provision for doubtful accounts receivable 504 705 366
Deferred income tax benefit (1,710) (18,678) (15,955)
License agreement acquisition charge -- -- 45,215
Loss on disposal of equipment 94 94 6
Equity loss in unconsolidated affiliate -- 49 --
Minority interest 2,282 1,474 417
Changes in assets and liabilities, net of acquisitions:
Accounts receivable (25,007) (19,606) (12,456)
Other receivables (12,794) (6,968) (6,515)
Inventories (17,489) (9,777) 2,867
Prepaid expenses 77 (1,142) (2,130)
Prepaid income taxes (3,054) 2,647 902
Other assets (3,328) (26,709) (1,819)
Accounts payable (2,120) (357) 2,006
Accrued income taxes 6,349 6,186 1,440
Accrued expenses 6,206 13,353 3,553
Product liability litigation (7,424) 48,000 --
- ----------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 15,999 10,912 30,721
- ----------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchase of short-term investments (347) (116) (18,284)
Proceeds from maturities of short-term investments 405 1,899 17,633
Proceeds from sale of equipment 774 34 19
Payments for purchase of property, plant and equipment (10,293) (7,110) (4,604)
Purchase of intangible assets (22,746) (18,538) (8,893)
Increase in notes receivable, other (1,716) -- (27)
Repayments of notes receivable, other 358 85 102
Acquisitions, net of cash acquired (1,420) (33,953) --
Payments for investment -- -- (2,585)
Investment in unconsolidated affiliates (146) -- --
Purchase of minority interest (483) (1,965) --
- ----------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (35,614) (59,664) (16,639)
- ----------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Increase in short-term borrowings 36,243 43,839 3,146
Proceeds from long-term debt 19,678 871 172
Repayment of long-term debt (52,438) (10,353) (12,954)
Repayment of stockholders' notes receivable 450 450 26
Proceeds from issuance of common stock 13,103 5,574 2,627
Capital contribution by minority shareholders 148 489 --
- ----------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 17,184 40,870 (6,983)
- ----------------------------------------------------------------------------------------------------------------
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CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
(in thousands)
for the years ended December 31,
- ------------------------------------------------------------------------------------------------------
1997 1996 1995
- ------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash 2,330 (618) (156)
- ------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (101) (8,500) 6,943
Cash and cash equivalents, beginning of period 2,830 11,330 4,387
- ------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 2,729 $ 2,830 $ 11,330
- ------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ 5,901 $ 4,605 $ 1,103
Cash paid during the year for income taxes $ 23,116 $ 11,015 $ 7,204
- ------------------------------------------------------------------------------------------------------
Supplemental schedule of non-cash investing and financing activities:
- - In 1997, 1996 and 1995, net income tax benefits of $7,324, $2,588 and
$934, 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.
- - During 1995, the Company incurred a liability of $45,215 in connection
with the acquisition of a license agreement.
The accompanying notes are an integral part of the consolidated
financial statements.
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NOTE TO CONSOLIDATED FINANCIAL STATEMENTS
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
(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
over which it maintains control. Minority interest represents minority
shareholders' proportionate share of their equity ownership 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, 1997 and
1996 and reported amounts of revenues and expenses for each of the
three years in the period ended December 31, 1997. Significant
estimates include those made for product liability litigation, the
allowance for doubtful accounts, inventory reserves for excess,
obsolete and damaged products, and accumulated depreciation and
amortization. Actual results could differ from those estimates made by
management.
NATURE OF OPERATIONS
The Company is primarily involved in developing, manufacturing and
marketing devices, instruments, computer-assisted visualization
products and biomaterials used in the treatment of spinal and cranial
disorders. The Company has subsidiaries located throughout North
America, Europe, Asia and Australia and has manufacturing facilities
located in Indiana, 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 healthcare cost containment
proposals on profitability, product
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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.
OTHER RECEIVABLES
Other receivables consist primarily of amounts due from insurance
carriers under the Company's product liability policies.
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, 1997, 1996 and 1995 totaled $7,011, $5,449 and
$4,366, 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.
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.
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REVENUE RECOGNITION
The Company derives revenues from both sales of products and certain
service functions. Sales are recognized primarily upon the shipment of
products to the customer or distributor. The revenues from services are
recognized at the time services are rendered.
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.
INTEREST RATE SWAP AGREEMENTS
During 1997, the Company entered into certain interest rate swap
agreements to reduce the impact of changes in interest rates on its
floating rate debt. The agreements are contracts to exchange floating rate
for fixed interest payments periodically over the life of the agreements
without the exchange of the underlying notional amounts. The notional
amounts of interest rate agreements are used to measure the interest to be
received or paid and do not represent the amount of exposure to credit
loss. The differential paid or received on interest rate agreements is
recognized as an adjustment to interest expense.
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 foreign currency 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 Company will continue to be
exposed to the effects of foreign currency translation adjustments. 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 a net loss in 1997 of $2,012 and net gains during 1996 and
1995 of $632 and $827, respectively. Gains and losses relative to
intercompany foreign currency transactions, for which settlement is
20
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not planned or anticipated in the foreseeable future, are excluded from
net income and reflected as cumulative translation adjustments.
3. INVENTORIES AND LOANER INVENTORIES
Net inventories at December 31, 1997 and 1996 consist of the following:
-----------------------------------------------------------------------
1997 1996
-----------------------------------------------------------------------
Finished goods $35,029 $28,260
Work-in-process 3,405 2,961
Raw materials 2,141 2,262
-----------------------------------------------------------------------
Inventories $40,575 $33,483
-----------------------------------------------------------------------
Loaner set inventories $21,511 $14,123
-----------------------------------------------------------------------
Loaner set inventories consist of inventory items on loan or available to
be loaned to customers.
4. ACQUISITIONS
The Company completed one acquisition in 1997 and four acquisitions in
1996. These acquisitions 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 December 1997, the Company acquired certain net assets of MAN Ceramics
GmbH, a privately held company located in Germany. MAN Ceramics designs,
manufactures and markets carbon fiber interbody fusion devices.
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 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 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.
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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 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.
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. The Company recorded adjustments to the purchase price
of these acquisitions of $5,072 and $4,174, in 1997 and 1996,
respectively. The Company is unable to determine whether such payments
will be required for the years 1998 and 1999.
The estimated fair values assigned to the assets and liabilities acquired
were as follows:
------------------------------------------------------------------------------------
1997 1996
------------------------------------------------------------------------------------
Total consideration paid $ 1,420 $ 38,796*
Fair value of liabilities assumed -- 6,935
Fair value of tangible and identifiable assets acquired (1,420) (11,528)
------------------------------------------------------------------------------------
Goodwill at acquisition date -- 34,203
Adjustments to purchase price 5,072 4,174
------------------------------------------------------------------------------------
Additions to goodwill $ 5,072 $ 38,377
------------------------------------------------------------------------------------
* Includes $2,585 paid in 1995.
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, 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, compared with the undiscounted
cashflows associated with the underlying asset. 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,
1997.
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A summary of intangible assets at December 31, is as follows:
----------------------------------------------------------------------------
1997 1996
----------------------------------------------------------------------------
Goodwill $ 46,125 $ 41,957
Patents 39,865 33,960
Trademarks 1,897 1,767
License agreements 12,062 9,009
Non-compete agreements 15,888 6,528
Other 1,378 3,770
----------------------------------------------------------------------------
117,215 96,991
Less: accumulated amortization (20,167) (13,565)
----------------------------------------------------------------------------
$ 97,048 $ 83,426
----------------------------------------------------------------------------
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 recorded at
December 31, 1997 represents the present value of the Company's remaining
obligation under the terms of the Agreement.
7. 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, 1997, is set forth below:
-----------------------------------------------------------------------------------
1997 1996 1995
-----------------------------------------------------------------------------------
REVENUES:
North America $ 243,094 $ 189,831 $ 147,025
Europe/Asia 87,493 70,410 49,260
Eliminations (17,685) (15,716) (7,486)
-----------------------------------------------------------------------------------
Total revenues $ 312,902 $ 244,525 $ 188,799
-----------------------------------------------------------------------------------
INCOME (LOSS) BEFORE TAXES AND
MINORITY INTERESTS:
North America $ 62,193 $ 1,244 $ (5,995)
Europe/Asia 21,946 12,790 5,060
-----------------------------------------------------------------------------------
Total income (loss) before
taxes and minority interests $ 84,139 $ 14,034 $ (935)
-----------------------------------------------------------------------------------
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Included in income (loss) before taxes and minority interest was a product
liability litigation charge of $50,000 in North America during 1996 and a
license agreement acquisition charge of $45,337 in North America during
1995.
-------------------------------------------------------------------
1997 1996
-------------------------------------------------------------------
IDENTIFIABLE ASSETS:
North America $ 319,606 $ 270,697
Europe/Asia 85,184 67,421
Eliminations (21,898) (21,898)
-------------------------------------------------------------------
Total identifiable assets 382,892 316,220
Corporate assets 2,765 2,941
-------------------------------------------------------------------
Total assets $ 385,657 $ 319,161
-------------------------------------------------------------------
Corporate assets are composed of cash, cash equivalents and short-term
investments.
The following amounts are included in the consolidated financial
statements for international subsidiaries:
--------------------------------------------------------------------------
1997 1996 1995
--------------------------------------------------------------------------
Current assets: $63,761 $52,240 $40,499
Property, plant and equipment,(net) 11,482 12,141 10,496
Intangible assets, (net) 12,921 6,303 5,909
Other assets, not itemized 1,985 2,629 1,561
--------------------------------------------------------------------------
90,149 73,313 58,465
--------------------------------------------------------------------------
Current liabilities: 24,104 33,343 18,240
Net intercompany balance 25,661 8,430 8,853
Long-term liabilities 3,111 2,416 1,396
--------------------------------------------------------------------------
52,876 44,189 28,489
--------------------------------------------------------------------------
Net assets $37,273 $29,124 $29,976
--------------------------------------------------------------------------
8. NOTES PAYABLE AND LINES OF CREDIT
At December 31, 1997 and 1996, the Company had a loan agreement with a
syndicate of U.S. banks, which provided for borrowings of up to $100,000
and $50,000, respectively, under a revolving line of credit. The Company
can 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 (5.7188% at December 31,
1997), PIBOR rate (3.5664% at December 31, 1997) and TIBOR rate (1.0007%
at December 31, 1997), 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
and maintenance of a certain debt service coverage ratio. The Company had
the equivalent of $55,573 and $35,087 outstanding under the revolving line
of credit at
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December 31, 1997 and 1996, respectively. During July, 1997, the Company
renegotiated its uncollateralized revolving line of credit. The revision
extended the maturity of this instrument to July 2000. At December 31,
1997, the balance sheet of the Company reflected the outstanding balance
as long-term debt.
As of December 31, 1997, the Company had entered into interest rate swap
agreements with certain financial institutions. The agreements effectively
fix the interest rate on floating rate debt at a rate of 7.625% and 6.965%
for notional principal amounts of $12,000 and $18,000, respectively.
At December 31, 1997, the Company also had loan agreements with various
international banks. The aggregate maximum borrowings available under
these committed lines of credit were equivalent to approximately $15,925
and bear interest at rates ranging from 0.25% to 20.0%. The Company had
approximately $11,731 and $15,120, outstanding under the revolving lines
of credit and various other short-term borrowings at December 31, 1997 and
1996, respectively.
The Company's weighted average interest rate on lines of credit and
short-term borrowings was approximately 6.4% and 6.5% at December 31, 1997
and 1996, respectively.
The Company has two stand-by letters of credit totaling $3,700. Amounts
available under the Company's $100,000 revolving line of credit are
reduced by the letters of credit.
9. LONG-TERM DEBT
In connection with 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 $1,012, $1,880, and
$1,650 relative to this agreement during 1997, 1996 and 1995,
respectively.
Long-term debt at December 31, 1997 and 1996 consists of:
-----------------------------------------------------------------------------
1997 1996
-----------------------------------------------------------------------------
Amounts payable under line of credit $55,573 -
Present value of amounts due under the G.I. 7,026 $ 22,998
Agreement
Subordinated note (convertible into 178,571
shares of common stock) 4,500 4,500
Various term loans with banks at fixed
interest rates from 0% to 8% maturing from
1998 to 2001 with annual installments 301 639
ranging from $10 to $212
Capital lease obligations 836 850
-----------------------------------------------------------------------------
68,236 28,987
Less current maturities (7,586) (16,687)
-----------------------------------------------------------------------------
$60,650 $ 12,300
-----------------------------------------------------------------------------
25
15
At December 31, 1997, aggregate required principal payments of long-term
debt, including capitalized lease obligations, are as follows:
1998 $ 7,586
1999 383
2000 55,751
2001 16
2002 -
Thereafter 4,500
-------------------------------------------------------------------------
$ 68,236
-------------------------------------------------------------------------
26
16
10. 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 through voting control of the
board of directors. KSD sells the Company's products exclusively to KPC.
During 1996 and 1997, the Company made prepayments totaling $28,700 of
commissions to KPC under a thirty year agreement. The Company is
amortizing the balance based upon sales to KPC. The Company has recorded
an aggregate of $27,763 and $26,338 included in prepaid expenses and other
assets, which represents the unamortized portion of the prepayment at
December 31, 1997 and 1996, respectively.
In November 1996, the Company established Sofamor Danek Korea Co., Ltd.
("SDK") in Korea. The Company and Joint Medical Company ("JMC") each hold
a 50% interest in SDK; however, the Company controls the financial and
operational direction of SDK through voting control of the board of
directors. SDK sells the Company's products primarily to JMC.
During 1997 and 1996, in the aggregate, the Company recorded sales of
$33,626 and $28,843, respectively, to KPC and JMC. At December 31, 1997
and 1996, the Company had total receivables, in the aggregate, of $11,320
and $8,498, respectively, from KPC and JMC.
11. INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31,
is as follows:
--------------------------------------------------------------------------------
U.S.
FEDERAL STATE FOREIGN TOTAL
--------------------------------------------------------------------------------
1997
Current $ 12,217 $ 678 $ 6,098 $18,993
Deferred 1,480 1,100 (3,824) (1,244)
--------------------------------------------------------------------------------
13,697 1,778 2,274 17,749
Charge in lieu of income taxes 7,093 231 - 7,324
--------------------------------------------------------------------------------
$ 20,790 $ 2,009 $ 2,274 $ 25,073
--------------------------------------------------------------------------------
1996
Current $ 11,062 $ 1,387 $ 4,676 $ 17,125
Deferred (16,010) (2,837) 427 (18,420)
--------------------------------------------------------------------------------
(4,948) (1,450) 5,103 (1,295)
Charge in lieu of income taxes 2,239 349 - 2,588
--------------------------------------------------------------------------------
$ (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)
--------------------------------------------------------------------------------
27
17
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:
---------------------------------------------------------------------------------------
1997 1996
---------------------------------------------------------------------------------------
Current deferred income tax assets:
Accounts receivable $ 100 $ 356
Inventory 6,574 3,680
Other 1,339 1,276
---------------------------------------------------------------------------------------
Total current deferred income tax assets 8,013 5,312
---------------------------------------------------------------------------------------
Non-current deferred income tax assets:
Product liability litigation 16,985 17,500
License agreement 12,959 14,017
Other 1,481 1,485
---------------------------------------------------------------------------------------
Total non-current deferred income tax assets 31,425 33,002
---------------------------------------------------------------------------------------
Total deferred income tax assets $ 39,438 $38,314
---------------------------------------------------------------------------------------
Non-current deferred income tax liabilities:
Property, plant and equipment - $ 121
---------------------------------------------------------------------------------------
Total non-current deferred income tax liabilities $ - $ 121
---------------------------------------------------------------------------------------
No valuation allowance was recorded since sufficient taxable income exists
in available carryback periods to fully recognize these net deferred tax
assets.
A reconciliation of federal statutory and effective income tax rates is as
follows:
---------------------------------------------------------------------------
1997 1996 1995
---------------------------------------------------------------------------
Statutory U.S. federal income tax rate 35.0% 35.0% 35.0%
Effect of:
Foreign operations (5.8) (12.3) 732.7
State income taxes, net of income 1.3 (7.3) (46.2)
tax benefit
Tax credits (0.7) (2.0) 20.5
Nondeductible amortization 0.6 (4.2) -
Other, net (0.6) - (66.2)
---------------------------------------------------------------------------
Effective rate 29.8% 9.2% 675.8%
---------------------------------------------------------------------------
12. 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
28
18
vesting of certain restricted stock. Interest was charged at the
applicable short-term federal rates 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 equal 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, 1997
and 1996 was $3,265 and $3,715, respectively. The loans are collateralized
by 200,000 shares of common stock.
13. COMMITMENTS AND CONTINGENCIES
The Company and its subsidiaries lease certain equipment and facilities
under non-cancelable operating leases expiring in 2008. The future annual
minimum rent payments under these leases at December 31, 1997 are as
follows:
------------------------------------------------------------------------
YEAR
------------------------------------------------------------------------
1998 $ 2,754
1999 2,334
2000 1,097
2001 1,049
2002 1,016
Thereafter 4,850
------------------------------------------------------------------------
$ 13,100
------------------------------------------------------------------------
Rent expense for 1997, 1996 and 1995, including month-to-month leases, was
approximately $2,975, $1,914 and $903, 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 generally provide
for royalty payments ranging from 1% to 10% of the net selling prices (as
defined by the agreements) of all such 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
$9,134, $6,768 and $5,907 in 1997, 1996 and 1995, respectively.
In 1996, the IRS began an examination of the Company's federal income tax
returns. The years under examination are 1993, 1994 and 1995. Management
believes that the resolution of any issues that may be developed as a
result of the examination will not have a significant impact on the
Company's results of operations or financial condition.
29
19
14. 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 LITIGATION
Beginning in 1994, the Company and other spinal implant manufacturers were
named as defendants in a number of product liability lawsuits brought in
various federal and state courts around the country. These lawsuits allege
that plaintiffs were injured by spinal implants manufactured by the
Company and others. The essence of the plaintiff's 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 of medical
devices), that pedicle fixation has not been proven safe and effective in
the context of FDA labeling standards, that some or all of the spinal
systems are defectively designed and manufactured and that plaintiffs have
suffered a variety of injuries as a result of their physicians' use of
such systems in pedicle fixation. The Company has also been named as a
defendant in a number of lawsuits instituted by plaintiffs who have
received spinal implants manufactured by other manufacturers and in which
the Company is alleged to have participated in a conspiracy among doctors,
manufacturers, hospitals, teaching institutions, professional societies
and others to promote, in violation of applicable law, the use of spinal
implants.
In a number of cases, plaintiffs have sought to proceed as representatives
of classes of spinal implant recipients. All efforts to obtain class
certification have been denied or withdrawn, except with respect to a
class-action settlement entered into between the plaintiffs and another
spinal implant manufacturer, AcroMed Corporation (see below under the
heading entitled "AcroMed Corporation Settlement"). 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. Plaintiffs typically seek relief in the
form of monetary damages, often in unspecified amounts. Many of the
plaintiffs only allege as monetary damage an amount in excess of the
jurisdictional minimum for the court in which the case has been filed. A
few suits also name as defendants various officers and directors of the
Company.
As of December 31, 1997, approximately 2,800 plaintiffs were joined in
lawsuits against the Company. The Company is also named as a defendant of
lawsuits involving about 2,600 claimants where the Company is alleged to
have conspired with competitors and others illegally to promote the use of
spinal implant systems.
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
30
20
Company has asserted and will continue to assert these 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 against them vigorously.
FEDERAL MULTIDISTRICT LITIGATION (MDL 1014)
On August 4, 1994, the Federal Judicial Panel for Multidistrict Litigation
ordered all federal court lawsuits to be transferred to and consolidated
for pretrial proceedings, including the determination of class
certification, in the United States District Court for the Easter District
of Pennsylvania in Philadelphia (the "Multidistrict Litigation"). Lawsuits
filed in federal court after August 4, 1994 have also been transferred to
and consolidated in the Multidistrict Litigation in the Easter District of
Pennsylvania. In addition, a number of lawsuits filed in state courts
around the country were removed to federal courts and then transferred
into the Multidistrict Litigation. On February 22, 1995, Chief Judge
Emeritus, Louis C. Bechtle, denied class certification. A large number of
plaintiffs filed individual lawsuits as a result of the denial of class
certification. In some instances, lawsuits that had been removed and
transferred into the Multidistrict Litigation have been remanded to the
state courts in which they were filed because there was no federal court
jurisdiction. As of December 31, 1997, the Company is a defendant in
approximately 920 individual claims and 1,065 conspiracy claims
consolidated in the Multidistrict Litigation. On April 16, 1997, Judge
Bechtle dismissed conspiracy claims alleging fraud on the FDA, but
deferred the remaining conspiracy claims for later consideration by the
federal trial courts to whom the cases will be remanded for trial.
Discovery has been completed in a number of the federal court cases and is
continuing in the remainder. A small number of cases have been transferred
to the federal courts in which they were filed for further proceedings and
trial. Judge Bechtle has begun the process of transferring the remaining
federal court cases to various federal courts throughout the United
States. As of December 31, 1997, the Federal Judicial Panel on
Multidistrict Litigation ordered the remand of approximately 210 cases to
transferor courts for further proceedings. It is not now possible to
determine when the first federal court cases will be tried.
STATE COURT LITIGATION
A number of cases filed in state courts were not eligible for removal and
transfer into the Multidistrict Litigation. As of December 31, 1997, there
were approximately 1,800 individual claims pending against the Company in
several courts around the country, principally in Tennessee, Oklahoma,
Texas and Pennsylvania. In addition, there were approximately 1,600
conspiracy claims pending in state courts.
Approximately 1,550 plaintiffs who had joined together in several
complaints which had been removed to the Multidistrict Litigation
proceedings have had their cases remanded to the state court in Memphis,
Tennessee, where they were originally filed when it was
31
21
determined that the federal court lacked jurisdiction over their
claims. The presiding state court judge in Memphis has established a
case management plan which calls for the preparation of eight
representative cases for preparation and trial.
Discovery is proceeding in all remaining state court cases. Some state
cases have been given trial dates in 1998. It is anticipated that a
number of other state court cases around the country may be scheduled
for trial in 1998, although delays in trial dates are common. Trials in
the Memphis proceedings are scheduled to begin in 1998.
ACROMED CORPORATION SETTLEMENT
In December 1996, AcroMed Corporation ("AcroMed"), a spinal implant
manufacturer and a defendant in many of the cases pending in the
Multidistrict Litigation, and the Plaintiff's Legal Committee in the
Multidistrict Litigation announced that they had entered into a
conditional settlement regarding all product liability claims involving
the use of AcroMed devices to achieve pedicular fixation with screws in
spinal fusion surgery. Under the terms of the settlement, AcroMed will
establish a settlement fund consisting of $100 million in cash plus the
proceeds of its product liability insurance policies. In January 1997,
the parties submitted a formal class settlement agreement and related
documentation for approval by Judge Bechtle. By order dated October 17,
1997, Judge Bechtle certified the proposed settlement class and
approved the proposed settlement. All federal and court proceedings
involving AcroMed devices have been stayed pending final jurisdictional
consideration of the proposed settlement.
INSURANCE
Several insurance carriers have asserted reservation of rights
concerning the scope and timing of the Company's remaining insurance
coverage, but have not denied insurance coverage by the Company. Three
of the carriers, Royal Surplus Lines Insurance Company ("Royal"),
Steadfast Insurance Company ("Steadfast") and Agricultural Excess and
Surplus Insurance Company ("Agricultural"), have each filed declaratory
judgment actions against the Company seeking clarification of their
rights and obligations, if any, under their respective policies.
Neither Royal nor Agricultural has paid amounts due to the Company;
Steadfast has paid only a portion of the amounts due to the Company.
The Royal and Steadfast lawsuits are pending in the United States
District Court for the Western District of Tennessee in Memphis. The
Agricultural lawsuit is pending in the United States District Court for
the Southern District of Ohio in Cincinnati. The Company believes that
the receivables are recoverable under the terms of the Royal, Steadfast
and Agricultural policies. The Company has filed an answer and
counterclaim in the Royal litigation and a motion seeking the interim
payment of the Company's defense costs. The Company has filed an answer
and counterclaim in the Steadfast litigation and intends to file an
answer and counterclaim in the Agricultural litigation. These
litigations are in the preliminary stages. The Company believes that
Royal's, Steadfast's and Agricultural's claims are without merit and
will defend against them vigorously.
32
22
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 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 is reflected in the Company's 1996 financial statements,
covers the reasonable foreseeable costs that the Company was positioned
in late December 1996 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 settlement
described above, the likelihood that the litigation will continue for
several years, in part, due to the additional financial resources
provided to the plaintiff's attorneys as a result of the AcroMed
settlement, 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 accrued liability which remained on the Company's
consolidated balance sheet at December 31, 1997 represents the
Company's best judgment of the probable reasonable costs (in excess of
amount of insurance the Company believes are recoverable) to defend and
conclude the lawsuits based on the facts and circumstances currently
existing. The costs provided for in the accrued liability 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 lawsuits could have a material effect on the Company's
results of operations and cash flows 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
purported 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
33
23
money damages. The alleged securities law violations are based on the
claim that the defendants failed to disclose that Company sold its
products illicitly, illegitimately and improperly and to timely
disclose facts concerning the termination of the former U.S.
distributor of Sofamor products, National Medical Specialties, Inc.
("NMS"). The allegations relating to illicit and illegitimate sales of
product are, for the most part, copies from product liability
complaints filed against the Company and other manufacturers currently
being coordinated in improper sales related 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 appealed the dismissal to
the United States Court of Appeals for the Sixth Circuit. On August 14,
1997, the Court of Appeals affirmed the dismissal of the plaintiffs'
complaint. The Court of Appeals denied the plaintiffs' request for
reconsideration on October 9, 1997. On January 6, 1998, the plaintiffs
filed a petition for certiorari in the United States Supreme Court.
The Company does not believe the Securities Laws Actions 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.
15. 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. During 1996,
the Board of Directors proposed an amendment to the 1990 Plan to
decrease the number of shares of the common stock available under the
Plan by 61,642.
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 ("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, to 3,500,000 in
34
24
1995 and to 6,000,000 in 1997. 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 1997, 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 1,500,000, contingent upon
approval by the Company's shareholders.
Activity under all of the stock option plans, including the 1,500,000
shares of common stock approved by the Board of Directors in 1997, for
the years ended December 31, 1997, 1996, and 1995 is summarized as
follows:
- -----------------------------------------------------------------------------------------------------------------
1997 1996 1995
------------------------- ------------------------ ------------------------
Weighted Weighted Weighted
Average Average Average
Option Exercise Option Exercise Option Exercise
Shares Price Shares Price Shares Price
- -----------------------------------------------------------------------------------------------------------------
Shares under option at
beginning of year 4,295,372 $18.80 3,597,939 $16.18 2,661,120 $13.96
Granted 1,965,800 $44.05 1,621,150 $25.82 1,453,700 $18.93
Exercised (754,771) $16.70 (417,744) $13.02 (231,653) $10.73
Canceled (201,640) $21.00 (505,973) $27.26 (285,228) $13.94
------------- ------------- -----------
Shares under option at end
of year 5,304,761 $28.38 4,295,372 $18.80 3,597,939 $16.18
- -----------------------------------------------------------------------------------------------------------------
Shares under option
exercisable at end of
year 1,380,345 1,175,832 863,739
Shares available for future
grant 1,786,307 2,057,068 733,887
- -----------------------------------------------------------------------------------------------------------------
Additional information regarding stock options outstanding at December
31, 1997 is shown below:
OUTSTANDING OPTIONS EXERCISEABLE OPTIONS
---------------------------------------------------------------------- ---------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
OPTION PRICE OPTION EXERCISE REMAINING OPTION EXERCISE
RANGE SHARES PRICE TERM SHARES PRICE
--------------------- ------------- --------- -------------- ------------- ----------------
$3.50 - $15.00 1,134,399 $12.73 6.4 679,339 $12.66
$15.01 - $25.00 1,529,994 $20.13 7.4 557,941 $19.65
$25.01 - $35.00 678,568 $27.26 8.5 115,065 $27.08
$35.01 - $45.00 886,600 $37.04 9.1 28,000 $37.50
$45.01 - $55.00 858,700 $48.09 9.7 - -
$55.01 - $65.00 216,500 $58.46 10.0 - -
35
25
The Company applies APB Opinion No. 25 and related Interpretations in
accounting for its plans. During 1995, the Financial Accounting
Standards Board issued Statement No. 123, "Accounting for Stock-Based
Compensation" ("FAS 123") changing the methods for recognition of cost
on plans similar to those of the Company. Adoption of the accounting
provisions of FAS 123 is optional; however, proforma disclosures as if
the Company adopted the cost recognition requirements under FAS 123 is
presented below:
- -----------------------------------------------------------------------------------------------------------
1997 1996 1995
--------------------- --------------------- ---------------------
AS AS AS
REPORTED PROFORMA REPORTED PROFORMA REPORTED PROFORMA
- ------------------------------- -------- ---------- -------- ---------- -------- ----------
Net income $56,784 $50,586 $ 11,267 $ 8,726 $ 4,967 $ 4,063
Net income per share - diluted $ 2.12 $ 1.89 $ 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 1997: dividend yield of
0%, expected volatility of 40.0%, risk-free interest rate of 6.1%, and
expected lives of 5.0 years; 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
$19.65, $12.59 and $8.20 in 1997, 1996 and 1995, respectively.
The effects of applying FAS 123 in this proforma disclosure are not
indicative of future amounts.
FAS 123 does not apply to awards prior to 1995, and additional awards
in future years are anticipated.
16. NET INCOME PER COMMON SHARE
In February 1997, the Financial Accounting Standards Board issued
Statement No. 128 ("FAS 128"). This statement establishes standards for
computing and presenting earnings per share ("EPS"). Basic EPS excludes
dilution and is computed by dividing income available to common
stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the
entity. FAS 128 requires restatement of all prior-period EPS data
presented.
Potential common stock is in the form of stock options which have an
effect on 1997, 1996 and 1995 diluted net income per common share
calculations. Potential common stock also includes assumed converted
debt securities. For the years ended December 31, 1997, 1996 and 1995,
net income was adjusted by $125, $124 and $115, respectively, to
calculate EPS.
36
26
This adjustment represented the interest charges, net of taxes, from
convertible debt which was assumed to be converted for the weighted
average number of shares calculation. The following table presents
information necessary to calculate diluted EPS for the years ended
December 31, 1997, 1996 and 1995:
37
27
------------------------------------------------------------------------------------
1997 1996 1995
------------------------------------------------------------------------------------
Diluted:
Weighted average shares outstanding 24,796,630 24,284,005 23,846,242
Shares equivalents 1,986,821 1,762,442 1,369,363
------------------------------------------------------------------------------------
26,783,451 26,046,447 25,215,605
------------------------------------------------------------------------------------
17. ACCRUED EXPENSES
Accrued expenses at December 31, 1997 and 1996 consist of the
following:
------------------------------------------------------------------------------------
1997 1996
------------------------------------------------------------------------------------
Amounts due to suppliers $ 1,820 $ 2,045
Commissions 5,510 5,001
Payroll, benefits, and related taxes 12,412 12,493
Royalties 3,727 2,288
Amount due to former shareholders of acquired companies 5,072 4,174
Interest 656 1,018
Product liability litigation 8,606 2,000
Legal 2,907 2,226
Other 9,384 7,525
------------------------------------------------------------------------------------
$ 50,094 $ 38,770
------------------------------------------------------------------------------------
18. 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
full-time employees that are 21 years of age and have completed at
least six months of continuous service with the Company. 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 vested in the sixth year of service. The
amounts charged against income in 1997, 1996, and 1995 were $800, $477
and $385, respectively.
In November 1991, the Company adopted an employee stock purchase plan
("ESPP") to provide employees the opportunity to purchase shares of
common stock of the Company. The ESPP covers full-time employees (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 1997, 1996 and 1995 was $33, $22 and $14, respectively, which
represented the Company's match of 15% of the employee's contribution.
38
28
19. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts for cash, short-term investments, notes and other
receivables, and notes and loans payable approximate fair value due to
the short maturity of these instruments.
The fair value of long-term debt is estimated based on current rates
available to the Company for debt with similar 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, 1997 and 1996 are as follows:
---------------------------------------------------------------------------------
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------- --------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
---------------------------------------------------------------------------------
Cash and cash equivalents $ 2,729 $ 2,729 $ 2,830 $ 2,830
Short-term investments 36 36 111 111
Other receivables 29,374 29,374 15,813 15,813
Notes payable and lines of credit 11,731 11,731 50,207 50,207
Long-term debt 68,236 75,388 28,987 30,778
20. SUBSEQUENT EVENTS
On January 26, 1998, the Company purchased Sofyc, S.A. ("Sofyc") for an
aggregate of 2,806,080 privately placed shares of the Company's common
stock, $1,000 in cash (less certain expenses relating to the
repurchase), and the Company's agreement to repay certain outstanding
loans of Sofyc equal to approximately $925. Sofyc is the personal
holding company of the Cotrel family and owner of approximately 14% or
3,337,272 shares of the Company's common stock. As a result of the
purchase of SOFYC, the outstanding shares of common stock of the
Company will be reduced by 531,192 shares. In accordance with the
purchase agreement, the Company filed a registration statement with the
Securities and Exchange Commission relating to a proposed public
offering of 1,600,000 shares of the common stock owned by the Cotrel
family. The registration statement also includes a proposed public
offering of up to 1,125,000 newly issued shares of common stock to be
sold by the Company and 75,000 shares to be sold by a director of the
Company. In addition, Sofamor Danek will grant to the underwriters an
over-allotment option relating to a maximum of 420,000 shares of common
stock. The Company expects to incur a foreign tax liability of
approximately $10,500 in connection with exchange of the Sofyc shares
which will result in an adjustment to equity by such amount.
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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,
- -----------------------------------
1997 $1,589 $504 $(199) (1) $(82) $1,812
1996 1,555 705 (698) (1) 27 1,589
1995 1,654 318 (704) (1) 287 1,555
(1) Amounts written off during the year
(2) Foreign currency translation adjustment
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
Our report on the consolidated financial statements of Sofamor Danek Group, Inc.
and subsidiaries is included in Exhibit 99.1 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 contained in Exhibit 99.1
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
February 2, 1998