-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Nyd2qFW9BDfF3EXgnOkR+fodn3bqlJLrabcy4UrrybsBf1Dko4rPVwgo/wEVzUqT oNB0ttXEWnF3KRC2qwOyHA== 0000950144-97-011922.txt : 19971120 0000950144-97-011922.hdr.sgml : 19971120 ACCESSION NUMBER: 0000950144-97-011922 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971112 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOFAMOR DANEK GROUP INC CENTRAL INDEX KEY: 0000873730 STANDARD INDUSTRIAL CLASSIFICATION: 3842 IRS NUMBER: 351580052 STATE OF INCORPORATION: IN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-12544 FILM NUMBER: 97714105 BUSINESS ADDRESS: STREET 1: 1800 PYRAMID PLACE CITY: MEMPHIS STATE: TN ZIP: 38132 BUSINESS PHONE: 9013962695 MAIL ADDRESS: STREET 1: 1800 PYRAMID PL CITY: MEMPHIS STATE: TN ZIP: 38132 FORMER COMPANY: FORMER CONFORMED NAME: DANEK GROUP INC /IN DATE OF NAME CHANGE: 19930328 10-Q 1 SOFAMOR DANEK FORM 10-Q 9-30-97 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1997 ----------------------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to _______________ Commission File Number: 000-19168 ----------------------------------------------------- Sofamor Danek Group, Inc. - - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Indiana 35-1580052 - - -------------------------------------------------------------------------------- (State or other jurisdiction (I.R.S. Employer Identification Number) of incorporation or organization) 1800 Pyramid Place, Memphis, Tennessee 38132 - - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (901) 396-2695 - - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) - - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [x] Yes [ ] No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 25,022,516 shares of common stock outstanding as of September 30, 1997 - - -------------------------------------------------------------------------------- 2 PART I - FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARES)
SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------ ------------ (UNAUDITED) ASSETS Current Assets: Cash and cash equivalents $5,553 $2,830 Short-term investments 70 111 Accounts receivable--trade, less allowance for doubtful accounts of $1,693 and $1,589 for September 30, 1997 and December 31, 1996, respectively 77,089 70,031 Other receivables 25,733 15,813 Inventories 45,775 33,483 Loaner set inventories 22,064 14,123 Prepaid expenses 4,422 6,318 Prepaid income taxes 8,496 -- Current deferred income taxes 5,360 5,312 -------- -------- Total current assets 194,562 148,021 Property, plant and equipment Land 1,481 1,484 Buildings 10,771 11,261 Machinery and equipment 34,055 32,083 Automobiles 744 708 -------- -------- 47,051 45,536 Less accumulated depreciation (22,824) (20,026) -------- -------- 24,227 25,510 Investments 1,061 920 Intangible assets, net 89,787 83,426 Other assets 32,194 28,282 Non-current deferred income taxes 32,698 33,002 -------- -------- Total assets $374,529 $319,161 ======== ========
The accompanying notes are an integral part of the consolidated financial statements. 2 3 SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (CONTINUED) (IN THOUSANDS, EXCEPT SHARES)
SEPTEMBER 30, DECEMBER 31, 1997 1996 --------- --------- (UNAUDITED) LIABILITIES Current Liabilities: Notes payable and lines of credit $12,465 $50,207 Current maturities of long-term debt 7,584 16,687 Accounts payable 5,732 7,332 Income taxes payable 2,838 3,898 Accrued expenses 36,651 38,770 Deferred income taxes 603 -- -------- -------- Total current liabilities 65,873 116,894 Long-term debt, less current maturities 70,239 12,300 Deferred income taxes 294 121 Product liability litigation 43,099 48,000 Minority interest 3,430 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: 25,708,424 and 25,094,277 shares issued (including 685,908 shares held in treasury) at September 30, 1997 and December 31, 1996, respectively 68,392 52,994 Retained earnings 138,875 98,044 Cumulative translation adjustment (1,973) 2,542 -------- -------- 205,294 153,580 Less: Cost of common stock held in treasury (9,985) (9,985) Unearned compensation -- (54) Stockholder notes receivable (3,715) (3,715) -------- -------- Total stockholder's equity 191,594 139,826 -------- -------- Total liabilities and stockholder's equity $374,529 $319,161 ======== ========
The accompanying notes are an integral part of the consolidated financial statements. 3 4 SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, 1997 1996 1997 1996 --------- --------- --------- --------- Revenues $ 78,006 $ 63,206 $ 221,378 $ 174,244 Cost of goods sold 14,631 10,363 39,661 30,710 --------- --------- --------- --------- Gross Profit 63,375 52,843 181,717 143,534 Operating Expenses: Selling, general and administrative 35,321 30,617 102,652 83,389 Research and development 4,822 4,267 14,319 11,824 --------- --------- --------- --------- Total operating expenses 40,143 34,884 116,971 95,213 --------- --------- --------- --------- Income from operations 23,232 17,959 64,746 48,321 Other income (expense) (23) (339) 232 731 Interest expense (1,530) (1,119) (4,221) (2,691) --------- --------- --------- --------- Income from operations before provision for and charge in lieu of income taxes 21,679 16,501 60,757 46,361 Provision for and charge in lieu of income taxes 6,613 5,030 17,946 13,224 --------- --------- --------- --------- Income before minority interest 15,066 11,471 42,811 33,137 Minority interest (662) (446) (1,980) (1,295) --------- --------- --------- --------- Net income $ 14,404 $ 11,025 $ 40,831 $ 31,842 ========= ========= ========= ========= Fully diluted net income per share $ 0.53 $ 0.42 $ 1.51 $ 1.22 ========= ========= ========= ========= Weighted average common shares outstanding 27,138 26,144 27,062 26,076 ========= ========= ========= =========
Note: Primary weighted average shares approximate fully diluted weighted average shares. The accompanying notes are an integral part of the consolidated financial statements. 4 5 SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 1997 1996 -------- -------- Cash flows from operating activities: Net income $ 40,831 $ 31,842 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 12,363 7,034 Provision for doubtful accounts receivable 393 403 Deferred income tax (benefit) expense 556 (2,084) Gain on disposal of equipment 11 19 Equity (income) loss in unconsolidated affiliate (108) 49 Minority interest 1,980 1,295 Changes in assets and liabilities, net of acquisitions: Accounts receivable (10,386) (8,629) Other receivables (9,342) (9,824) Inventories and loaner set inventories (22,090) (7,180) Prepaid expenses 1,759 1,604 Prepaid income taxes (8,498) 3,053 Other assets (3,960) (14,969) Accounts payable (1,112) (1,809) Income taxes payable 4,830 4,983 Accrued expenses (907) 4,598 Product liability litigation (4,901) -- -------- -------- Net cash provided by operating activities 1,419 10,385 -------- -------- Cash flows from investing activities: Purchase of short-term investments (2) (116) Proceeds from maturities of short-term investments 33 1,899
The accompanying notes are an integral part of the consolidated financial statements. 5 6 SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 1997 1996 -------- -------- Payments for purchase of property, plant and equipment (6,055) (4,698) Proceeds from sale of equipment 404 34 Purchase of intangible assets (14,471) (10,003) Increase in notes receivable, other (844) -- Repayments of notes receivable, other 56 66 Investment in unconsolidated affiliates (142) -- Acquisitions, net of cash acquired -- (30,042) Purchase of minority interest 483 (1,974) -------- -------- Net cash used by investing activities (20,538) (44,834) -------- -------- Cash flows from financing activities: Increase in short-term borrowings 28,799 34,514 Proceeds from long-term debt 174 575 Repayment of long-term debt (16,250) (10,117) Proceeds from issuance of common stock 9,815 3,686 Capital contribution by minority shareholders 148 428 -------- -------- Net cash provided by financing activities 22,686 29,086 -------- -------- Effect of exchange rate changes on cash (844) 348 -------- -------- Increase (decrease) in cash and cash equivalents 2,723 (5,015) Cash and cash equivalents, beginning of period 2,830 11,330 -------- -------- Cash and cash equivalents, end of period $ 5,553 $ 6,315 ======== ========
Supplemental disclosure of non-cash investing and financing activities: - In 1997 and 1996, net income tax benefits of $5,583 and $2,437, respectively, were realized by the Company as a result of certain common stock options being exercised and vesting of certain restricted common stock, reducing accrued federal and state income taxes payable and increasing common stock. - During July, 1997, the Company renegotiated its $80,000 uncollateralized revolving line of credit. The revision extended the maturity of this instrument to July 2000. As a result of the renegotiation, $65,028 was reclassified from a current liability to a long-term liability. The accompanying notes are an integral part of the consolidated financial statements. 6 7 SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (IN THOUSANDS) 1. Financial Statement Presentation The consolidated balance sheet as of September 30, 1997, the consolidated statements of income for the three and nine months ended September 30, 1997 and 1996, and the consolidated statements of cash flows for the nine months ended September 30, 1997 and 1996, are unaudited but, in the opinion of management, include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of financial position, results of operations and cash flows. Accordingly, certain information and footnote disclosures normally included in complete financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. It is suggested that these consolidated financial statements be read in conjunction with the financial statements and notes thereto included in the Company's 1996 Annual Report on Form 10-K. 2. Inventories and Loaner Set Inventories Net inventories and loaner set inventories consist of:
------------------------------------------------------------------------------------------------------- September 30, December 31, 1997 1996 ------------------------------------------------------------------------------------------------------- Finished goods $38,739 $28,260 Work-in-process 4,317 2,961 Raw materials 2,719 2,262 ------------------------------------------------------------------------------------------------------- Net inventories $45,775 $33,483 ------------------------------------------------------------------------------------------------------- Loaner set inventories, net $22,064 $14,123 -------------------------------------------------------------------------------------------------------
3. Income Taxes The Company's effective income tax rate was 30.5% for the quarters ended September 30, 1997 and 1996. The effective rates were 29.5% and 28.5% for the nine months ended September 30, 1997 and 1996, respectively. The difference between the Company's effective and statutory tax rates for both the quarter and nine months ended September 30, 1997 and 1996, 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. At September 30, 1997, the balance sheet of the Company reflected a net deferred tax asset of 7 8 $37,161. No valuation allowance was recorded since sufficient taxable income existed in available carryback periods to recognize fully these net deferred tax assets. During the first nine months of 1997 and 1996, charges in lieu of income taxes of $5,583 and $2,437, respectively, were recorded by the Company as a result of certain common stock options being exercised and vesting of certain restricted common stock. 4. Adoption of SFAS 128 In March 1997, the Financial Accounting Standards Board (the "Board") issued Statement No. 128 "Earnings Per Share" ("FAS 128"). FAS 128 establishes standards for computing and presenting earnings per share ("EPS") and replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the statement of operations and requires a reconciliation of the numerator and the denominator of the basic EPS computation to the numerator and the denominator of the diluted EPS computation. The Company will adopt the disclosure requirements of FAS 128 beginning December 31, 1997. The Company does not expect the adoption of FAS 128 to have a material impact on earnings per share when presented on a comparable basis. 5. Revolving Line of Credit During July, 1997, the Company renegotiated its $80,000 uncollateralized revolving line of credit. The revision extended the maturity of this instrument to July 2000. At September 30, 1997, the balance sheet of the Company reflected the outstanding balance as long-term debt. 6. Commitments and Contingencies The Company is involved from time to time in litigation on various matters which are routine to the conduct of its 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. Although the plaintiffs have advanced claims under many different legal theories, the essence of their 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 Food & Drug Administration ("FDA") rules and regulations (governing marketing and labeling), 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 8 9 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 for the settlement proposed by AcroMed Corporation (see below under the heading entitled AcroMed Corporation Proposed 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 damages 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. To date, approximately two thousand eight hundred (2,800) plaintiffs have joined in lawsuits against the Company. The majority of these plaintiffs filed their claims in 1995. The Company is also named as a defendant in lawsuits involving about two thousand six hundred (2,600) claimants where the Company is alleged to have conspired illegally with competitors and others 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 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 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 for the Eastern 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 Eastern 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. Currently, the Company is a defendant in approximately one thousand (1,000) individual claims and one thousand (1,000) conspiracy claims consolidated in the Multidistrict Litigation. On August 22, 1996, Judge Bechtle dismissed without prejudice plaintiffs' conspiracy claims. Most plaintiffs asserting conspiracy claims in the Multidistrict Litigation have filed amended or new 9 10 complaints. It is not possible to determine at this time precisely how many of these conspiracy complaints will be reasserted or the number of additional plaintiffs that may file new lawsuits. 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 stated that he intends to begin the process of transferring the remaining federal court cases in November, 1997 to various federal courts throughout the United States. 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. Currently, there are approximately one thousand eight hundred (1,800) individual claims pending against the Company in several courts around the country, principally in Tennessee, Oklahoma, Texas and Pennsylvania. In addition, there are approximately one thousand six hundred (1,600) conspiracy claims pending in state courts. Approximately one thousand five hundred fifty (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 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 pretrial 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 PROPOSED 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 proposed 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 court proceedings involving AcroMed devices have been stayed pending final judicial consideration of the proposed settlement. 10 11 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 to the Company. Three of the carriers, 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 have 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 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 them 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. The Company's 1996 financial results reflect a pre-tax charge relating to costs associated with the product liability litigation described above. 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 11 12 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 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. 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. 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 June 1993, an accrual was established, with a related charge to earnings, for this pending litigation. 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 would have involved a complete retrial of all issues. The former Spanish distributor filed an appeal and sought additional damages; the Company sought to have the decision of the Commercial Court reversed. The case has been settled, and under the terms of the settlement, the Company has received approximately $300 thousand of the award back from the former Spanish distributor. 12 13 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following table sets forth for the periods indicated, selected unaudited financial information expressed as a percentage of revenues and the period-to-period change in such information.
PERIOD-TO-PERIOD CHANGE ----------------------- THREE NINE MONTHS MONTHS ENDED ENDED SEPTEMBER SEPTEMBER THREE MONTHS NINE MONTHS 30, 1997 30, 1997 ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, VS VS 1997 1996 1997 1996 1996 1996 ----- ----- ----- ----- ---- ---- Revenues 100.0% 100.0% 100.0% 100.0% 23.4% 27.1% Cost of goods sold 18.8 16.4 17.9 17.6 41.2 29.1 ----- ----- ----- ----- ---- ---- Gross profit 81.2 83.6 82.1 82.4 19.9 26.6 Operating expenses: Selling, general and administrative 45.2 48.4 46.4 47.9 15.4 23.1 Research and development 6.2 6.8 6.5 6.8 13.0 21.1 ----- ----- ----- ----- ---- ---- Total operating expenses 51.4 55.2 52.9 54.7 15.1 22.9 Income from operations 29.8 28.4 29.2 27.7 29.4 34.0 Other income (expense) (0.0) (0.5) 0.1 0.4 93.2 (68.3) Interest expense (2.0) (1.8) (1.9) (1.5) 36.7 56.9 ----- ----- ----- ----- ---- ---- Income from operations before provision for and charge in lieu of income taxes 27.8 26.1 27.4 26.6 31.4 31.1 Provision for and charge in lieu of income taxes 8.5 8.0 8.1 7.6 31.5 35.7 ----- ----- ----- ----- ---- ---- Income before minority interest 19.3 18.1 19.3 19.0 31.3 29.2 Minority interest (0.8) (0.7) (0.9) (0.7) 48.4 52.9 ----- ----- ----- ----- ---- ---- Net income 18.5% 17.4% 18.4% 18.3% 30.6% 28.2% ===== ===== ===== ===== ==== ====
RESULTS OF OPERATIONS* The Company reported record revenues of $78.0 million and $221.4 million for the quarter and nine months ended September 30, 1997, respectively. Third quarter 1997 revenues increased $14.8 million or 23.4%, compared with the third quarter of 1996. An increase in volume contributed revenue growth of 21.9%. The Company's conversion of certain portions of its international distribution network to direct sales, which resulted in higher selling prices, contributed a 2.7% increase. Other net pricing changes in existing distribution channels resulted in a 2.4% increase in revenues. If exchange rates had been constant, revenues would have reflected an additional 3.6% increase compared with the third quarter of 1996. - - ---------- * Except for the historical information contained in this Quarterly Report on Form 10-Q, the matters discussed herein (including, in particular, those discussed in Part II, Item 1, "Legal Proceedings") 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 certain other risks and uncertainties detailed from time to time in the Company's periodic reports (including the Annual Report on Form 10-K for the year ended December 31, 1996) filed with the Securities and Exchange Commission and "Factors That May Affect Future Operating Results and Financial Condition" detailed in this Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. 13 14 Revenues for the nine months ended September 30, 1997, represented a $47.1 million or 27.1% increase over the same period in 1996. Higher volume generated 25.3% revenue growth. The Company's conversion of certain portions of its international distribution network to direct sales, which resulted in higher selling prices, contributed a 2.5% increase. Other net pricing changes in existing distribution channels resulted in a 2.8% increase in revenues. If exchange rates had been constant, revenues would have reflected an additional 3.5% increase compared with the first nine months of 1996. U.S. revenues increased 22.5% to $52.7 million and 29.0% to $149.8 million during the quarter and nine months ended September 30, 1997, respectively, from the same periods in 1996. The Company believes the improvement in U.S. revenues is primarily the result of the increasing number of instrumented spinal fusions, as well as the acceptance of new products and services such as the STEALTHSTATION (TM) System and the MEDNEXT(R) Surgical Drill System, and service fees related to cortical bone dowel and other allograft bone products. Non-U.S. revenues advanced 25.5% to $25.3 million and 23.1% to $71.6 million during the third quarter and first nine months of 1997, respectively, from the same periods in 1996. If exchange rates had been constant, the revenue increases for the third quarter and first nine months of 1997 over the comparative periods in 1996 would have been 36.4% and 33.6%, respectively. Higher sales volume in core products and the acceptance of new products were the primary sources of the increases in revenues for the quarter and nine months ended September 30, 1997, compared with the same periods in 1996. In addition, the Company's revenues continued to benefit from the direct sales operations which were established in selected countries during 1996 and the first nine months of 1997. The Company's third quarter 1997 gross margin of 81.2% decreased 2.4 percentage points compared with the third quarter 1996 gross margin of 83.6%. The Company's gross margin was 82.1% for the nine months ended September 30, 1997, compared with 82.4% recorded in the first nine months of 1996. The decreases in gross margin during the quarter and nine months ended September 30, 1997, were primarily attributable to the effects of changes in production levels to achieve reductions in inventory levels from the previous quarter. Selling, general, and administrative ("SG&A") expenses expressed as a percentage of revenues decreased to 45.2% in the third quarter of 1997, compared with 48.4% during the same period in 1996. SG&A expenses for the first nine months of 1997 were 46.4% of revenues, down from 47.9%, during the first nine months of 1996. The decreases in SG&A expenses as a percentage of revenues resulted from the leveraging of fixed costs over greater revenue volume, despite higher expenses incurred in direct sales operations established in selected countries during 1996 and the first nine months of 1997. Research and development ("R&D") expenses totaled $4.8 million, or 6.2% of revenues, for the third quarter of 1997, compared with $4.3 million, or 6.8% of revenues, for the third quarter of 1996. For the first nine months of 1997, R&D expenses were $14.3 million or 6.5% of revenues compared to 6.8% of revenues for the same period in 1996. In dollars, R&D spending increased 13.0% and 21.1% for the quarter and nine months ended September 30, 1997, respectively, over the same periods in 1996. These development and clinical costs are incurred as the Company continues to enhance existing product lines and develop new and complementary products, such 14 15 as the 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. These expenditures demonstrate the Company's continued commitment to the pursuit of applying new medical technologies to product opportunities. Interest expense for the quarter and nine months ended September 30, 1997, was $1.5 million and $4.2 million, respectively, compared with $1.1 and $2.7 million, respectively, for the same periods in 1996. Interest expense was higher during the quarter and nine months ended September 30, 1997, compared with the same periods in the prior year, due to interest on increased borrowings against the Company's credit facilities occurring principally as a result of acquisitions made in 1996. The Company's effective income tax rate was 30.5% for the quarters ended September 30, 1997 and 1996. The effective tax rates were 29.5% and 28.5% for the nine months ended September 30, 1997 and 1996, respectively. The difference between the Company's effective and statutory tax rates for both the quarter and nine months ended September 30, 1997 and 1996, resulted primarily from the impact of certain elections made for U.S. tax purposes following the combination in June 1993 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 among other factors. Higher future pre-tax income could lead to higher future effective tax rates. At September 30, 1997, the balance sheet of the Company reflected a net deferred tax asset of $37.2 million. No valuation allowance was recorded since sufficient taxable income exists in available carryback periods to recognize fully these net deferred tax assets. In June 1997, the Financial Accounting Standards Board issued Statement No. 128 "Earnings Per Share" ("FAS 128"). FAS 128 establishes standards for computing and presenting earnings per share ("EPS") and replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the statement of operations and requires a reconciliation of the numerator and the denominator of the basic EPS computation to the numerator and the denominator of the diluted EPS computation. The Company will adopt the disclosure requirements of FAS 128 beginning December 31, 1997. The Company does not expect the adoption of FAS 128 to have a material impact on earnings per share when presented on a comparable basis. LIQUIDITY AND CAPITAL RESOURCES Cash generated from operations and the Company's revolving lines of credit are the principal sources of funding available for growth of the business, including working capital and additions to property, plant and equipment, as well as debt service requirements and required contractual payments. The Company believes that these sources of funding will be sufficient to meet its expected cash needs for the foreseeable future. Cash, cash equivalents and short-term investments totaled $5.6 million at September 30, 1997, compared with $2.9 million at December 31, 1996. 15 16 The Company's working capital increased by $97.6 million during the first nine months of 1997. The increase in working capital resulted primarily from the renegotiation of the Company's uncollateralized revolving line of credit which extended the maturity of the instrument from October 1997 to July 2000 (see Note 5 to the financial statements set forth in Item 1) and from operations. Accounts receivable increased $7.1 million or 10.1% from December 31, 1996, due principally to the 11.0% increase in revenues in the third quarter of 1997 compared with the fourth quarter of 1996. Inventories and loaner set inventories increased by $20.2 million from year-end, due mostly to stocking levels required for recently formed subsidiaries and the production of inventories in preparation for new sales and marketing programs. Other receivables, which consisted primarily of amounts recoverable from insurance carriers related to the expenses incurred in connection with product liability litigation (see Part II, Item I, under the heading entitled Insurance), increased $9.9 million from the previous year-end. In 1995, the Company entered into a license agreement (the "Agreement") with Genetics Institute which resulted in a special charge of $45.3 million. The Company made payments in June 1997 and 1996 of $17.5 million and $12.5 million, respectively, as required by the Agreement. The final scheduled payment of $7.5 million is payable on June 30, 1998. All payments include both principal and imputed interest. The purchase agreements for two of the acquisitions made by the Company in 1996 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 of $4.2 million. This amount was paid during April of 1997. The Company is unable to determine whether such payments will be required for the years 1997 through 1999. 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. At September 30, 1997, the balance sheet of the Company reflected a liability of $47.2 million of which $43.1 million was reflected as a long-term liability and $4.1 million was included in accrued expenses. (See Part II, Item 1.) Additions to property, plant and equipment during the first nine months of 1997 of $6.1 million were related to capital asset 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. Management has entered into an agreement whereby the Company will lease a new facility adjacent to its existing headquarters. This lease will be accounted for under Statement of Financial Accounting Standards No. 13, "Accounting for Leases," as an operating lease. The Company has committed lines of credit totaling $97.0 million. At September 30, 1997, $77,493 million was outstanding under these committed lines of credit and other short-term borrowings. The committed lines of credit consist primarily of a $80.0 million uncollateralized revolving line of credit with a U.S. bank which matures in July 2000. 16 17 The Company invests available funds in short-term investment grade instruments, certificates of deposit, and direct and 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 or acquiring new products in the past. There can be no assurance that the Company will be able to develop and introduce or acquire 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 17 18 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 6 to the Consolidated Financial Statements.) There can be no assurance that additional claims will not be asserted against 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. 18 19 PART II -- OTHER INFORMATION Item 1. LEGAL PROCEEDINGS The Company is involved from time to time in litigation on various matters which are routine to the conduct of its 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. Although the plaintiffs have advanced claims under many different legal theories, the essence of their 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 Food & Drug Administration ("FDA") rules and regulations (governing marketing and labeling), 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 for the settlement proposed by AcroMed Corporation (see below under the heading entitled AcroMed Corporation Proposed 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 damages 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. To date, approximately two thousand eight hundred (2,800) plaintiffs have joined in lawsuits against the Company. The majority of these plaintiffs filed their claims in 1995. The Company is also named as a defendant in lawsuits involving about two thousand six hundred (2,600) claimants where the Company is alleged to have conspired illegally with competitors and others 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 Company has 19 20 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 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 for the Eastern 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 Eastern 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. Currently, the Company is a defendant in approximately one thousand (1,000) individual claims and one thousand (1,000) conspiracy claims consolidated in the Multidistrict Litigation. On August 22, 1996, Judge Bechtle dismissed without prejudice plaintiffs' conspiracy claims. Most plaintiffs asserting conspiracy claims in the Multidistrict Litigation have filed amended or new complaints. It is not possible to determine at this time precisely how many of these conspiracy complaints will be reasserted or the number of additional plaintiffs that may file new lawsuits. 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 stated that he intends to begin the process of transferring the remaining federal court cases in November, 1997 to various federal courts throughout the United States. 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. Currently, there are approximately one thousand eight hundred (1,800) individual claims pending against the Company in several courts around the country, principally in Tennessee, Oklahoma, Texas and Pennsylvania. In addition, there are approximately one thousand six hundred (1,600) conspiracy claims pending in state courts. Approximately one thousand five hundred fifty (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 determined that the federal court lacked jurisdiction over their claims. The presiding 20 21 state court judge in Memphis has established a case management plan which calls for the preparation of eight representative cases for pretrial 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 PROPOSED 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 proposed 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 court proceedings involving AcroMed devices have been stayed pending final judicial 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 to the Company. Three of the carriers, 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 have 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 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 them 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. 21 22 The Company's 1996 financial results reflect a pre-tax charge relating to costs associated with the product liability litigation described above. 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 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. 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. 22 23 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 June 1993, an accrual was established, with a related charge to earnings, for this pending litigation. 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 would have involved a complete retrial of all issues. The former Spanish distributor filed an appeal and sought additional damages; the Company sought to have the decision of the Commercial Court reversed. The case has been settled, and under the terms of the settlement, the Company has received approximately $300 thousand of the award back from the former Spanish distributor. See Part I, Item 2, "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 and Intellectual Property." Item 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibit No. Description ----------- ----------- 27 Financial Data Schedule (for SEC use only) b) Reports on Form 8-K None. 23 24 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SOFAMOR DANEK GROUP, INC. ------------------------- (Registrant) DATE: November 12, 1997 BY: /s/ E.R. Pickard --------------------- --------------------- E.R. Pickard Chairman, Chief Executive Officer and Director (Principal Executive Officer) DATE: November 12, 1997 BY: /s/ George G. Griffin, III --------------------- ------------------------------- George G. Griffin, III Executive Vice President and Chief Financial Officer (Principal Financial Officer) 24 EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 9-MOS DEC-31-1997 JAN-1-1997 SEP-30-1997 5,553 70 78,782 1,693 67,839 194,562 47,051 22,824 374,529 65,873 70,239 0 0 68,392 123,202 374,529 221,378 221,378 39,661 39,661 14,319 393 4,221 60,757 17,946 40,831 0 0 0 40,831 1.51 1.51
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