<PAGE> 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, 1996
------------------
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)
<TABLE>
<S> <C>
Indiana 35-1580052
- --------------------------------------------------------------------------------------------------------------------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification Number)
1800 Pyramid Place, Memphis, Tennessee 38132
- --------------------------------------------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
</TABLE>
(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.
24,377,183 shares of common stock outstanding as of September 30, 1996
- --------------------------------------------------------------------------------
Page 1 of 27
Exhibit Index Appears on Page 25
<PAGE> 2
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARES)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
ASSETS (UNAUDITED)
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 6,315 $ 11,330
Short-term investments 113 1,924
Accounts receivable--trade, less allowance for
doubtful accounts of $1,461 and $1,555 for
September 30, 1996 and December 31, 1995,
respectively 59,336 50,451
Other receivables 18,706 9,257
Inventories 31,658 25,723
Loaner set inventories 13,084 10,803
Prepaid expenses 3,617 5,092
Prepaid income taxes 8 2,648
Current deferred income taxes 6,965 4,699
-------- --------
Total current assets 139,802 121,927
Property, plant and equipment
Land 1,488 1,505
Buildings 11,351 10,878
Machinery and equipment 30,411 25,723
Automobiles 428 231
-------- --------
43,678 38,337
Less accumulated depreciation (18,963) (15,714)
-------- --------
24,715 22,623
Notes receivable - other 166 170
Investments 952 3,600
Intangible assets, net 68,518 29,600
Other assets 18,409 3,427
Non-current deferred income taxes 14,718 15,266
-------- --------
$267,280 $196,613
======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
2
<PAGE> 3
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARES)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
LIABILITIES (UNAUDITED)
<S> <C> <C>
Current liabilities:
Notes payable $ 40,833 $ 6,516
Current maturities of long-term debt 16,624 10,086
Accounts payable 5,570 6,513
Accrued federal income taxes 345 --
Accrued foreign income taxes 3,034 539
Accrued expenses 27,031 21,134
-------- --------
Total current liabilities 93,437 44,788
Long-term debt, less current maturities 12,293 28,125
Deferred income taxes -- 191
Minority interest 1,839 580
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: 25,063,091 and 24,672,131 shares
issued (including 685,908 and 678,433 shares held in
treasury) at September 30, 1996 and December 31, 1995,
respectively 52,316 44,832
Retained earnings 118,619 86,777
Cumulative translation adjustment 3,022 5,542
-------- --------
173,957 137,151
Less:
Cost of common stock held in treasury (9,985) (9,736)
Unearned compensation (96) (321)
Stockholders' notes receivable (4,165) (4,165)
-------- --------
159,711 122,929
-------- --------
$267,280 $196,613
======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
3
<PAGE> 4
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1996 1995 1996 1995
------- ------- -------- --------
<S> <C> <C> <C> <C>
Net Sales $63,206 $47,188 $174,244 $134,590
Cost of goods sold 10,363 9,926 30,710 29,123
------- ------- -------- --------
Gross profit 52,843 37,262 143,534 105,467
Operating expenses:
Selling, general and administrative 30,617 22,311 83,389 63,982
Research and development 4,267 3,426 11,824 10,403
License agreement acquisition charge -- -- -- 45,337
------- ------- -------- --------
34,884 25,737 95,213 119,722
------- ------- -------- --------
Income (loss) from operations 17,959 11,525 48,321 (14,255)
Other income (expense) (339) 174 731 2,775
Interest expense (1,119) (681) (2,691) (2,012)
------- ------- -------- --------
Income (loss) from operations before
provision (benefit) for and charge
in lieu of income taxes 16,501 11,018 46,361 (13,492)
Provision (benefit) for and charge in
lieu of income taxes 5,030 2,237 13,224 (8,912)
------- ------- -------- --------
11,471 8,781 33,137 (4,580)
Minority interest (446) (166) (1,295) (287)
------- ------- -------- --------
Net income (loss) $11,025 $ 8,615 $ 31,842 ($ 4,867)
======== ======= ======== ========
Net income (loss) per common share $ 0.42 $ 0.34 $ 1.22 ($ 0.19)
======= ======= ======== ========
Weighted average common shares
outstanding 26,144 25,592 26,076 25,283
======= ======= ======== ========
</TABLE>
Note: Primary weighted average shares approximate fully diluted weighted
average shares.
The accompanying notes are an integral part of the consolidated financial
statements.
4
<PAGE> 5
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
1996 1995
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Income (loss) from continuing operations $ 33,137 $ (4,580)
Minority interest in consolidated earnings (1,295) (287)
-------- --------
Net income (loss) 31,842 (4,867)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 7,034 5,753
Provision for doubtful accounts receivable 403 264
Deferred income tax benefit (2,084) (15,870)
License agreement acquisition charge -- 45,215
Loss on disposal of equipment 19 12
Equity (income) loss in unconsolidated affiliate 49 (219)
Minority interest in net income of consolidated subsidiaries 1,295 287
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable (8,629) (4,365)
Other receivables (9,824) 112
Inventories (7,180) 1,091
Prepaid expenses 1,604 247
Prepaid income taxes 3,053 (30)
Other assets (14,969) (1,929)
Accounts payable (1,809) (1,385)
Accrued state income and franchise taxes -- 314
Accrued federal income taxes 2,341 62
Accrued foreign income taxes 2,642 (66)
Accrued expenses 4,598 (1,728)
-------- --------
Net cash provided by operating activities 10,385 22,898
-------- --------
Cash flows from investing activities:
Purchase of short-term investments (116) (11,570)
Proceeds from maturities of short-term investments 1,899 10,764
Proceeds from sale of equipment 34 --
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
5
<PAGE> 6
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (CONTINUED)
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
1996 1995
-------- --------
<S> <C> <C>
Payments for purchase of property, plant and equipment (4,698) (3,024)
Purchase of intangible assets (10,003) (6,091)
Increase in notes receivable, other -- (23)
Repayments of notes receivable, other 66 70
Acquisitions, net of cash acquired (30,042) (2,585)
Purchase of minority interest (1,974) --
-------- --------
Net cash used by investing activities (44,834) (12,459)
-------- --------
Cash flows from financing activities:
Increase in short-term borrowings 34,514 3,867
Proceeds from long-term debt 575 108
Repayment of long-term debt (10,117) (12,856)
Repayment of stockholders' notes receivable -- 26
Proceeds from issuance of common stock 3,686 1,770
Capital contribution by minority shareholder 428 --
-------- --------
Net cash provided (used) by financing activities 29,086 (7,085)
-------- --------
Effect of exchange rate changes on cash 348 (187)
-------- --------
Increase (decrease) in cash and cash equivalents (5,015) 3,167
Cash and cash equivalents, beginning of period 11,330 4,387
-------- --------
Cash and cash equivalents, end of period $ 6,315 7,554
======== ========
</TABLE>
Supplemental disclosure of non-cash investing and financing activities:
- In 1996 and 1995, net income tax benefits of $2,437 and $378, 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 the first nine months of 1996, $250 of accounts receivable were
written off against the allowance for doubtful accounts.
- During March of 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.
6
<PAGE> 7
SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. Financial Statement Presentation
The consolidated balance sheet as of September 30, 1996, the consolidated
statements of income for the three months and nine months ended September
30, 1996 and 1995, and the consolidated statements of cash flows for the
nine months ended September 30, 1996 and 1995 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.
Certain information and footnote disclosures normally included in
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 1995
Annual Report on Form 10-K.
2. Inventories and Loaner Set Inventories
Net inventories and loaner set inventories consist of:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------
September 30, December 31,
1996 1995
------------------------------------------------------------------------------
<S> <C> <C>
Finished goods $ 26,289 $ 21,238
Work-in-process 3,353 3,017
Raw materials 2,016 1,468
------------------------------------------------------------------------------
Net inventories $ 31,658 $ 25,723
------------------------------------------------------------------------------
Loaner set inventories, net $ 13,084 $ 10,803
------------------------------------------------------------------------------
</TABLE>
3. Intangible Assets
Net intangible assets consist of:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------
September 30, December 31,
1996 1995
------------------------------------------------------------------------------
<S> <C> <C>
Goodwill $ 29,958 $ 1,115
Patents and trademarks 24,293 15,911
Other 14,267 12,574
------------------------------------------------------------------------------
Total net intangible assets $ 68,518 $ 29,600
------------------------------------------------------------------------------
</TABLE>
7
<PAGE> 8
4. Income Taxes
The Company's effective income tax rates were 30.5% and 28.5%,
respectively, for the quarter and nine months ended September 30, 1996.
The effective rate for the third quarter of 1995 was 20.3% and the
effective rate of the net tax benefit for the nine months ended September
30, 1995 was 66.1%. The tax benefit of $8,912 recorded during the first
nine months of 1995 resulted primarily from the one-time license agreement
acquisition charge to earnings of $45,337. Without the $45,337 one-time
charge, the tax expense for the first nine months of 1995 would have been
$6,956 or a 21.8% effective tax rate. The difference between the Company's
effective and statutory tax rates for both the quarter and nine months
ended September 30, 1996 and 1995 resulted primarily from the impact of
the effects of certain elections made for U.S. tax purposes following the
combination (the "Combination") of Danek Group, Inc. with Sofamor S.A.
("Sofamor"), and the subsequent reorganization of Sofamor from a Societe
Anonyme (S.A.) under French law to a Societe en Nom Collectif (S.N.C.) in
late 1993. Management cannot be certain that such a favorable effective
income tax rate will be achieved in future periods, since the effective
tax rate calculation is dependent upon the Company's pre-tax income dollar
amount. The effective tax rates for the quarter and nine months ended
September 30, 1996, were higher than the same periods of 1995 (without the
one-time charge for the nine months ended September 30, 1995) primarily
due to higher pre-tax income and greater taxable income in jurisdictions
with higher tax rates. Higher future pre-tax income could lead to higher
future effective tax rates. At September 30, 1996, the balance sheet of
the Company reflected a net deferred tax asset of $21,683, which resulted
primarily from the one-time license agreement acquisition charge. No
valuation allowance was recorded since sufficient taxable income exists in
available carryback periods to recognize fully these net deferred tax
assets.
During the first nine months of 1996 and 1995, charges in lieu of income
taxes of $2,437 and $378, respectively, were recorded by the Company as a
result of certain common stock options being exercised and vesting of
certain restricted common stock.
5. Commitments and Contingencies
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
Multidistrict Litigation:
In 1994, the Company and other spinal implant manufacturers were named as
defendants in purported class action product liability lawsuits in various
federal courts throughout the country alleging that plaintiffs were
injured by spinal implants manufactured by the Company and others. On
August 4, 1994, the Federal Judicial Panel on Multidistrict
8
<PAGE> 9
Litigation ordered that all federal court lawsuits then existing be
transferred to and consolidated for pretrial proceedings, including the
determination of class certification, in the Federal District Court for
the Eastern District of Pennsylvania in Philadelphia. Federal court
lawsuits filed after August 4, 1994 have also been transferred to and
consolidated in the Eastern District of Pennsylvania. On February 22,
1995, Chief Judge Emeritus Louis C. Bechtle denied class certification.
The federal court lawsuits before Judge Bechtle will remain coordinated
for further pretrial purposes but are individual lawsuits. As anticipated
and previously disclosed, as a result of the denial of class certification
by Judge Bechtle, a large number of additional plaintiffs have filed
lawsuits alleging injuries caused by spinal implants manufactured by the
Company. To date, approximately two thousand eight hundred (2,800)
plaintiffs have filed lawsuits against the Company, with a few also naming
as defendants various officers and directors of the Company. Also,
plaintiffs' lawyers have filed several lawsuits involving approximately
two thousand eight hundred fifty (2,850) claimants alleging a conspiracy
theory among doctors, manufacturers (including the Company), hospitals,
teaching institutions, professional societies and others to promote in
violation of applicable law the use of spinal implants. Some plaintiffs
have filed individual lawsuits, whereas other lawsuits list multiple
plaintiffs or in certain instances multiple lawsuits have been filed on
behalf of the same individual plaintiffs. On August 22, 1996, Judge
Bechtle dismissed without prejudice plaintiffs' conspiracy claims. The
Company anticipates that most plaintiffs asserting these conspiracy claims
will file amended or new complaints, but it is not possible at this time
to estimate precisely how many of these conspiracy complaints will be
reasserted or the number of additional plaintiffs that may file lawsuits.
The majority of such lawsuits were filed in federal courts throughout the
country and are in the preliminary stages. Discovery proceedings,
including the taking of depositions, have been ongoing in certain of the
lawsuits that were first to be filed. Discovery in certain cases filed
later may begin in the fourth quarter of this year. A number of the
plaintiffs are having their lawsuits returned to the state court in
Memphis, Tennessee. It is anticipated that the Memphis, Tennessee state
court judge will establish a schedule for case management and discovery.
The trials of a number of lawsuits involving individual plaintiffs are
scheduled to begin in the first six months of 1997, although delays in
trial dates are common. Although plaintiffs have advanced claims under
many different legal theories, the essence of plaintiffs' claims appears
to be that the Company (including Sofamor and its former U.S. distributor)
marketed some of its spinal systems for pedicle fixation in contravention
of FDA rules and regulations (governing marketing and labeling), that
pedicle fixation has not been proven safe and efficacious in the context
of FDA labeling standards and that plaintiffs have suffered a variety of
injuries as a result of the use of the systems for pedicle fixation.
Plaintiffs in these cases typically seek relief in the form of monetary
damages, often in unspecified amounts. Many of the plaintiffs only allege
as monetary damages an amount in excess of the jurisdictional minimum for
the courts in which such cases are filed.
On April 8, 1996, Judge Bechtle issued a ruling that would have resulted
in the dismissal of many of the claims existing against the Company in the
multidistrict litigation. Judge Bechtle's ruling granted defendant
AcroMed Corporation's motion for summary judgment
9
<PAGE> 10
on claims involving failure to warn, manufacturing, design and testing
defects, implied warranty, negligence and defect per se. (AcroMed
Corporation is a spinal implant manufacturer and a defendant in various of
the cases pending in the multidistrict litigation). The Court held that
under applicable Third Circuit precedent, all of these claims were
expressly preempted by the medical device provisions of the Food, Drug and
Cosmetic Act ("FDCA"). The Court's ruling left only claims for breach of
express warranty and unlawful promotion (excluding device labeling) as a
basis for a federal court lawsuit involving spinal implants. The Court
further provided that plaintiffs may seek reinstatement of some or all of
the dismissed claims if the U.S. Supreme Court's decision in Lohr v.
Medtronics altered the existing Third Circuit law on federal preemption.
On June 26, 1996, the Supreme Court ruled in Lohr v. Medtronics that the
preemption provision contained in the medical device amendments of the
FDCA does not expressly preempt state tort causes of actions. On the
basis of this decision the plaintiffs have sought reinstatement of all
claims previously dismissed by Judge Bechtle's April 8, 1996 ruling and
the Company expects that those claims will be reinstated. The ruling in
Lohr v. Medtronics also applies to all pending state court cases.
Tennessee and Oregon Product Liability Actions:
In January 1995, the Company and other spinal implant manufacturers,
doctors and a hospital were named defendants in a purported class action
product liability lawsuit filed in Nashville, Tennessee state court. This
lawsuit is limited to those individuals whose surgeries were performed at
one specific hospital. Class certification has been denied by the trial
judge in Nashville. Discovery has only recently begun in these individual
cases. In October 1995, the Company was served with a Portland, Oregon
state court complaint that purported to be a class action. This Oregon
complaint alleged, among other things, injury based upon various legal
theories. In March 1996, the plaintiffs in this Oregon case withdrew the
class allegations. Discovery has begun in these individual cases. In
these Tennessee and Oregon actions, plaintiffs, who seek relief in the
form of monetary damages of unspecified amounts, are continuing their
lawsuits as individual cases.
The Company believes that all product liability lawsuits currently pending
against it are without merit and will continue to defend them vigorously.
All pending cases are currently being defended by insurance carriers,
generally under reservation of rights. 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.
While the aggregate monetary damages eventually sought by all of these
plaintiffs and the related costs to defend such actions may be substantial
and could exceed the limits of the Company's various insurance policies,
the Company believes that it has affirmative defenses, including, without
limitation, defenses based upon the expiration of the applicable statute
of limitations, the learned intermediary defense and the failure of a
cause of action to
10
<PAGE> 11
exist where no malfunction of the implant has occurred or the plaintiff
has suffered no injury attributable to the Company's product. The Company
has and will continue to assert the affirmative defenses primarily through
the filing of dispositive motions. As noted above, the Company also
believes that all of these individual lawsuits are without merit.
SECURITIES LAWS ACTIONS
Beginning in April 1994, the Company and four of its officers and
directors were named in five shareholder lawsuits filed in Federal
District Court in Memphis, Tennessee. Four of the lawsuits purport to be
class actions. All of the lawsuits have been consolidated into one case
in Federal 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 state material facts to the
investing public and seeks money damages. The alleged securities law
violations are premised 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 Federal 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 Federal
District Court Judge in Memphis dismissed with prejudice the entire case
against the Company and each of the individual defendants. The plaintiffs
have appealed the dismissal, and oral arguments relating to this appeal
were heard on October 22, 1996 by the United Stated Court of Appeals for
the Sixth Circuit.
SPANISH DISTRIBUTOR ACTION
In late September 1994, a Magistrate of the Commercial Court in Paris
ruled in favor of a former Spanish distributor of Sofamor's products on a
claim of wrongful termination of the distribution agreement in 1992.
Prior to the Combination, an accrual was established, with a related
charge to earnings, for this pending litigation. On the Combination date
in June 1993, the Company also established a separate indemnity with
respect to potential losses resulting from such lawsuit and placed in
escrow shares issued to the former Sofamor shareholders pending the
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 and the former distributor have each appealed this
ruling. The appeal process requires a retrial of all issues and is
currently scheduled for the fourth quarter of 1997.
11
<PAGE> 12
The Company does not believe that any pending litigation, including the
actions described above, will have a material adverse effect on its
consolidated financial position, results of operations or cash flows
because of, among other reasons, the facts and circumstances existing with
respect to each action, the Company's belief that certain actions are
without merit, certain defenses available to the Company and the
availability of insurance in certain actions.
CONTINGENT FUTURE PAYMENTS
In May 1996, the Company purchased the remaining 80.5% of the outstanding
stock of Surgical Navigation Technologies, Inc. ("SNT"). The Company had
purchased 19.5% of the outstanding stock of SNT in March of 1995. Pursuant
to the purchase agreement, contingent upon the generation of certain
revenues and earnings relative to SNT products, the Company may be required
to make future payments to the former shareholders of SNT for each year
through 1999, which will be recorded as adjustments to the purchase price.
As the requirement to make future payments is subject to the realization of
certain revenues and earnings in each calendar year, the Company is unable
to determine at this time whether any such payment will be required for the
years 1997 through 1999. For 1996, the Company anticipates that a
contingent payment will be due, but it is unable at this time to determine
the amount of any such required payment.
In July 1996, the Company acquired all of the 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. The Company will be required to make future
payments to the former shareholders of MedNext, Inc. in the event that sales
of MEDNEXT(R) products exceed specific annual targets in any of 1997,
1998, or 1999, which will be recorded as adjustments to the purchase price.
As the requirement to make future payments is subject to the realization of
certain revenues in 1997, 1998 or 1999, the Company is unable to determine
at this time whether any such payments will be required.
12
<PAGE> 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 net sales
and the period-to-period change in such information.
<TABLE>
<CAPTION>
PERIOD-TO-PERIOD CHANGE
THREE NINE
MONTHS MONTHS
ENDED ENDED
THREE MONTHS NINE MONTHS SEPTEMBER SEPTEMBER
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, 30, 1996 30, 1996
VS VS
1996 1995 1996 1995 1995 1995
------ ------ ------ ------ --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Net Sales 100.0% 100.0% 100.0% 100.0% 33.9% 29.5%
Cost of goods sold 16.4 21.0 17.6 21.6 4.4 5.4
------ ------ ------ ------
Gross profit 83.6 79.0 82.4 78.4 41.8 36.1
Operating expenses:
Selling, general and administrative 48.4 47.3 47.9 47.6 37.2 30.3
Research and development 6.8 7.3 6.8 7.7 24.5 13.7
License agreement acquisition charge -- -- -- 33.7 -- (100.0)
------ ------ ------ ------
55.2 54.6 54.7 89.0 35.5 (20.5)
------ ------ ------ ------
Income (loss) from operations 28.4 24.4 27.7 (10.6) 55.8 439.0
Other income (expense) (0.5) 0.4 0.4 2.1 (294.8) 73.7
Interest expense (1.8) (1.4) (1.5) (1.5) 64.3 33.7
------ ------ ------ ------
Income (loss) from operations before
provision (benefit) for and charge in
lieu of income taxes 26.1 23.4 26.6 (10.0) 49.8 443.6
Provision (benefit) for and charge in
lieu of income taxes 8.0 4.8 7.6 (6.6) 124.9 248.4
------ ------ ------ ------
18.1 18.6 19.0 (3.4) 30.6 823.5
Minority interest in consolidated earnings
(with no applicable income taxes) (0.7) (0.3) (0.7) (0.2) 168.7 351.2
------ ------ ------ ------
Net income (loss) 17.4% 18.3% 18.3% (3.6)% 28.0% 754.2%
====== ====== ====== ======
</TABLE>
See the accompanying notes to the consolidated financial statements.
13
<PAGE> 14
OVERVIEW*
In March 1995, Sofamor Danek purchased 19.5% of the outstanding stock of
Surgical Navigation Technologies, Inc. ("SNT") and acquired the exclusive
worldwide license (except in Korea until 1997) to manufacture and distribute
SNT products relating to frameless stereotactic surgery in spinal and
neurological fields. In May 1996, the Company acquired the remaining 80.5% of
the outstanding stock of SNT. Pursuant to the purchase agreement, contingent
upon the generation of certain revenues and earnings relative to SNT products,
the Company may be required to make future payments to the former shareholders
of SNT for each year through 1999, which will be recorded as adjustments to the
purchase price. As the requirement to make future payments is subject to the
realization of certain revenues and earnings in each calendar year, the Company
is unable to determine at this time whether any such payment will be required
for the years 1997 through 1999. For 1996, the Company anticipates that a
contingent payment will be due, but it is unable at this time to determine the
amount of any such required payment.
In July 1996, the Company acquired certain net assets of TiMesh, Inc., a
privately held company located in Las Vegas, Nevada. The net assets acquired
are used in the design, manufacture and marketing of titanium plates and
titanium alloy screws.
Also, in July 1996, the Company acquired all of the capital stock of MedNext,
Inc., a privately held company located in West Palm Beach, Florida that
designs, manufactures and markets powered surgical instrumentation and
accessories for surgical specialties. The Company will be required to make
future payments to the former shareholders of MedNext, Inc. in the event that
sales of MEDNEXT(R) products exceed specific annual targets in any of 1997,
1998, or 1999, which will be recorded as adjustments to the purchase price. As
the requirement to make future payments is subject to the realization of
certain revenues in 1997, 1998 or 1999, the Company is unable to determine at
this time whether any such payments will be required.
In August 1996, the Company entered into an exclusive agreement with The
University of Florida Tissue Bank, Inc. ("UFTB") to provide services related
to their cortical bone dowel and other allograft bone products.
*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, 1995
and the Quarterly Report on Form 10-Q for the quarter ended June 30, 1996)
filed with the Securities and Exchange Commission.
14
<PAGE> 15
RESULTS OF OPERATIONS
The Company reported NET SALES of $63.2 million and $174.2 million for the
quarter and nine months ended September 30, 1996, respectively. Third quarter
1996 net sales increased $16.0 million or 33.9%, compared with the third
quarter of 1995. The growth in net sales included an increase of 11.7% that
resulted from the Company's conversion of certain portions of its international
distribution network to direct sales which resulted in higher selling prices.
Other net pricing changes in existing distribution channels caused an increase
of 3.9%. Additional sales volume accounted for the remainder of the increase
in net sales.
Net sales for the nine months ended September 30, 1996, represented a $39.7
million, or 29.5% increase, over the same period in 1995. Net sales growth
included an increase of 8.5% that resulted from the Company's conversion of
certain portions of its international distribution network to direct sales
which resulted in higher selling prices. Other net pricing changes in existing
distribution channels caused an increase of 3.8%. Additional sales volume
accounted for the remainder of the increase in net sales. Changes in exchange
rates had an immaterial impact on net sales for the quarter and nine months
ended September 30, 1996.
U.S. SALES increased 32.7% to $43.0 million and 27.1% to $116.1 million during
the third quarter and first nine months of 1996, respectively, from the same
periods in 1995. The Company believes the improvement in U.S. sales is
primarily the result of an increased number of instrumented fusions as well as
the acceptance of new products such as the STEALTHSTATION(TM) system, the
TIMESH(TM) cranial plating system, and the MEDNEXT(R) surgical drill system.
NON-U.S. SALES advanced 36.7% to $20.2 million and 34.6% to $58.1 million
during the third quarter and first nine months of 1996, respectively, from the
same periods in 1995. The strong international sales growth in the third
quarter and first nine months of 1996, compared with the same periods of 1995,
primarily reflects the Company's establishing a direct sales presence in
selected strategic countries as well as enhanced international sales and
marketing programs. In February 1996, the Company formed a new subsidiary in
Japan, Kobayashi Sofamor Danek K.K. ("KSD"). KSD is owned 50% each by the
Company and Kobayashi Pharmaceutical Co., Ltd. ("KPC"), which has served as the
Company's distributor to Japan. KSD has a total of 9 directors, of whom 5 have
been designated by the Company. The Company controls the operations of KSD
which are consolidated in the Company's financial statements. The Company
sells the product it manufactures to KSD, which in turn resells the product at
near retail prices through KPC's distribution network. The Company's
international sales also benefited from the formation of wholly owned
subsidiaries in Canada in April and in Australia in August of this year.
The Company's GROSS MARGIN improved during the third quarter of 1996 to 83.6%
from 79.0% in the same quarter of 1995. Gross margin increased during the nine
months ended September 30, 1996 to 82.4% from 78.4% in the same period of 1995.
The enhancement in gross margin from the third quarter and the first nine
months of 1995 is due to greater leveraging of
15
<PAGE> 16
manufacturing costs due to increased volume, higher margins due to changes in
international distribution, and favorable shifts in the sales mix of certain
products and sales programs.
SELLING, GENERAL, AND ADMINISTRATIVE (S,G,&A) EXPENSES were 48.4% of sales
during the third quarter of 1996 compared with 47.3% during the third quarter
of 1995. The increase in S,G,&A expenses for the quarter as a percentage of
sales relates mostly to expenses incurred by KSD and, to a lesser extent, the
new subsidiaries in Canada and Australia. S,G,&A expenses were 47.9% of sales
for the nine months ended September 30, 1996 compared with 47.6% for the same
period of 1995. This increase in S,G,&A expenses as a percentage of sales
relates to international subsidiaries formed in 1996.
RESEARCH AND DEVELOPMENT (R&D) EXPENSES totaled $4.3 million or 6.8% of net
sales, for the third quarter of 1996, compared with $3.4 million or 7.3% of net
sales, for the third quarter of 1995. For the first nine months of 1996,
research and development expenses were $11.8 million or 6.8% of net sales
compared to $10.4 million or 7.7% of sales for the same period of 1995. These
costs are incurred as the Company continues to enhance existing product lines
and develop new and complementary products for use in spinal surgery, such as
the interbody fusion devices, biological products for use in spinal
reconstruction, and products related to frameless stereotactic surgery in the
spinal and neurological fields of use. These expenditures demonstrate the
Company's continued commitment to the pursuit of applying new medical
technologies to product opportunities.
In the first quarter of 1995, the Company recorded a $45.3 million one-time
LICENSE AGREEMENT ACQUISITION CHARGE to earnings (which represents the net
present value of $50.0 million of payments due under the terms of the license
agreement between the Company and Genetics Institute (the "G.I. Agreement")
plus related transaction costs) to reflect the acquisition of exclusive North
American rights to Genetics Institute's recombinant human bone morphogenetic
protein (rhBMP-2) for spinal applications.
For the quarter ended September 30, 1996, the Company recorded OTHER EXPENSE of
$339,000, which was primarily due to foreign exchange losses, compared with
OTHER INCOME of $174,000 recorded during the third quarter of 1995, which was
mostly a result of interest income on investments. For the nine months ended
September 30, 1996 and 1995, the Company recorded OTHER INCOME of $731,000, and
$2.8 million, respectively. Other income was higher during the first nine
months of last year due mainly to the reversal of certain risk provisions and
greater foreign exchange gains.
INTEREST EXPENSE for the quarters ended September 30, 1996 and 1995, was $1.1
million and $681,000, respectively. Interest expense was higher during the
third quarter of 1996 compared with the prior year due to interest expense on
increased borrowings against the Company's credit facilities occurring
principally as a result of the acquisitions described above in the overview
section. For the nine months ended September 30, 1996 and 1995, interest
expense was $2.7 million and $2.0 million, respectively. There was no interest
incurred under the G.I. Agreement during the first quarter of 1995.
16
<PAGE> 17
The Company's effective INCOME TAX RATES were 30.5% and 28.5%, respectively,
for the quarter and nine months ended September 30, 1996. The effective rate
for the third quarter of 1995 was 20.3% and the effective rate of the net tax
benefit for the nine months ended September 30, 1995 was 66.1%. The tax
benefit of $8.9 million recorded during the first nine months of 1995 resulted
primarily from the one-time license agreement acquisition charge to earnings of
$45.3 million described above in connection with the acquisition of exclusive
rights from Genetics Institute. Without the $45.3 million one-time charge, the
tax expense for the first nine months of 1995 would have been $7.0 million or a
21.8% effective tax rate. The difference between the Company's effective and
statutory tax rates for both the quarter and nine months ended September 30,
1996 and 1995 resulted primarily from the impact of the effects of certain
elections made for U.S. tax purposes following the combination of Danek Group,
Inc. with Sofamor S.A. ("Sofamor"), and the subsequent reorganization of
Sofamor from a Societe Anonyme (S.A.) under French law to a Societe en Nom
Collectif (S.N.C.) in late 1993. Management cannot be certain that such a
favorable effective income tax rate will be achieved in future periods, since
the effective tax rate calculation is dependent upon the Company's pre-tax
income dollar amount. The effective tax rates for the quarter and nine months
ended September 30, 1996, were higher than the same periods of 1995 (without
the one-time charge for the nine months ended September 30, 1995) primarily due
to higher pre-tax income and greater taxable income in jurisdictions with
higher tax rates. Higher future pre-tax income could lead to higher future
effective tax rates. At September 30, 1996, the balance sheet of the Company
reflected a net deferred tax asset of $21.7 million, which resulted primarily
from the one-time license agreement acquisition charge. No valuation allowance
was recorded since sufficient taxable income exists in available carryback
periods to recognize fully these net deferred tax assets.
Management believes that inflation has not had a material impact on the
Company's business.
LIQUIDITY AND CAPITAL RESOURCES
Cash generated from operations and the Company's revolving line of credit are
the principal sources of funding available for the growth of the business,
including working capital, additions to property, plant and equipment as well
as debt service requirements and required contractual payments. Cash, cash
equivalents and short-term investments totaled $6.4 million at September 30,
1996, compared with $13.3 million at December 31, 1995.
In connection with the formation of KSD in February 1996, the Company made a
$15.0 million prepayment of commissions to KPC. During the next twelve months,
the Company plans to make additional prepayments of commissions to KPC totaling
an estimated $8.0 to $10.0 million.
In connection with the G.I. Agreement, the Company has recorded a liability of
$23.0 million at September 30, 1996, which represents the present value of the
$25.0 million in remaining scheduled payments. Of this amount, $7.0 million is
classified as long-term debt and $16.0 million is reflected as a current
liability, representing the principal portion of the $17.5 million payable on
June 30, 1997. The final payment of $7.5 million is due in June of 1998.
17
<PAGE> 18
The Company's working capital decreased $30.8 million during the first nine
months of 1996. The change in working capital was primarily due to the
payments required in connection with the acquisitions of SNT, MedNext, Inc.,
and certain net assets of TiMesh, Inc., the prepayment of commissions to KPC,
the $12.5 million payment due under the G.I. Agreement and the $6.2 million
increase in the current portion of the Genetic's Institute obligation. These
uses of working capital were partially offset by favorable cash flows from
ongoing operations. Net accounts receivable increased $8.9 million from
December 31, 1995, due primarily to the increase in net sales. Inventories and
loaner set inventories increased $8.2 million due to additional inventory
acquired in connection with the 1996 acquisitions described above, stocking
levels required for recently formed subsidiaries, and the manufacture of loaner
set inventories in preparation for new sales and marketing programs. Other
receivables increased $9.4 million from the Company's previous year-end,
primarily due to amounts recoverable from the Company's insurance carriers
relative to expenses incurred in connection with product liability litigation.
Additions to property, plant and equipment during the first nine months of 1996
of $5.3 million were related to capital assets acquired in the formation and
acquisition of new subsidiaries and other capital expenditures necessary to
support the Company's manufacturing and distribution operations. Net intangible
assets increased by $38.9 million from December 31, 1995, primarily due to the
intangible assets relative to the acquisitions of SNT, MedNext, Inc. and
certain net assets of TiMesh, Inc.
The Company has committed lines of credit totaling approximately $57.8 million.
At September 30, 1996, $40.1 million was outstanding under the Company's credit
facilities. The committed lines of credit consist primarily of a $50.0 million
uncollateralized revolving line of credit with a U.S. bank which is renewable
annually and matures October 15, 1997. The Company has the option to convert
the debt outstanding under this revolving line of credit to a term loan,
amortized on a quarterly basis over a term of up to three years.
The Company invests available funds in short-term investment grade instruments,
certificates of deposit or direct or guaranteed obligations of the United
States of America. These short-term investments are available to fund the
Company's working capital requirements and acquisitions of capital assets.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS AND FINANCIAL CONDITION
The Company's future operating results and financial condition are subject to
risks and uncertainties, including (without limitation) the following matters:
Regulatory Clearances. The Company manufactures devices that are subject to
regulations of the FDA and, in some cases, to 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
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<PAGE> 19
and sale of new products and devices by the Company. The enforcement of FDA
regulations depends heavily on administrative interpretation, and there can be
no assurance that future interpretations made by the FDA or other regulatory
bodies, with possible retroactive effect, will not adversely affect the
Company. The Company cannot predict the extent or impact of future foreign,
federal, state or local legislation or regulation.
Potential Impact of Health Care Cost Containment Proposals on Profitability.
In recent years, the cost of health care has risen significantly, and there
have been numerous proposals by legislators, regulators and third party health
care payers to curb these cost increases in the United States and Europe. Some
of these proposals have involved limitations on the amount of reimbursement for
specific surgical procedures. These proposals have been adopted in some cases.
The Company is unable to predict what changes will be made in the reimbursement
methods utilized by third party health care payers. In addition, hospitals and
other health care providers have become increasingly cost sensitive. To date,
the Company does not believe that such health care cost containment proposals
have negatively affected the profitability or growth of its business; however,
the Company is not able to predict the future effect of these proposals on its
business.
Product Obsolescence. Spinal implant and other devices are subject to
continuous improvements and modifications and typically are rendered obsolete
within a few years. Success, therefore, requires any medical device company to
devote substantial resources to continued product development. The Company
maintains active research and development programs and has been successful in
developing new products in the past. There can be no assurance that the
Company will be able to develop and introduce new products that will enable it
to remain competitive in the future.
Product Liability; Insurance. In recent years, physicians, hospitals, and
other participants in the health care industry have become subject to an
increasing number of lawsuits alleging malpractice or product liability or
asserting related legal theories, many of which involve large claims and
significant defense costs. As described in Part II, Item 1, "Legal
Proceedings," the Company is involved in product liability litigation. There
can be no assurance that additional claims will not be asserted against the
Company in the future. The Company currently maintains liability insurance
intended to cover such claims, although there can be no assurance that the
coverage limits of such insurance policies will be adequate. Such insurance is
expensive, difficult to obtain and may not be available in the future on
acceptable terms or at all. A successful claim brought against the Company in
excess of insurance coverage could have a material adverse effect upon the
Company and the financial condition, results of operations and 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. See Part II, Item 1, "Legal Proceedings."
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
19
<PAGE> 20
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 and
as needed. The Company also depends on its contractual relationships with
certain physicians for product ideas, research and advice. There can be no
assurance that the Company will be able to maintain and develop such
relationships.
Global Market Risks. A significant portion of the Company's revenue is derived
from its international operations. As a result, the Company's operations and
financial results could be affected by international factors, such as changes
in foreign currency exchange rates or weak economic conditions in the foreign
markets in which the Company distributes its products.
Intellectual Property. The Company is dependent on its proprietary
intellectual property and attempts to protect such intellectual property
through patents, licensing, trade secrets and proprietary know-how. In the
medical device industry, challenges by third parties regarding intellectual
property rights occur frequently. Such challenges may result in litigation
which is often complex and expensive. There can be no assurance that the
Company's proprietary rights will not be challenged, rendered unenforceable or
circumvented and that pending or future patent or trademark applications will
be granted.
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<PAGE> 21
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 this
business, including product liability and intellectual
property cases.
PRODUCT LIABILITY LITIGATION
Multidistrict Litigation:
In 1994, the Company and other spinal implant manufacturers
were named as defendants in purported class action product
liability lawsuits in various federal courts throughout the
country alleging that plaintiffs were injured by spinal
implants manufactured by the Company and others. On August 4,
1994, the Federal Judicial Panel on Multidistrict Litigation
ordered that all federal court lawsuits then existing be
transferred to and consolidated for pretrial proceedings,
including the determination of class certification, in the
Federal District Court for the Eastern District of
Pennsylvania in Philadelphia. Federal court lawsuits filed
after August 4, 1994 have also been transferred to and
consolidated in the Eastern District of Pennsylvania. On
February 22, 1995, Chief Judge Emeritus Louis C. Bechtle
denied class certification. The federal court lawsuits before
Judge Bechtle will remain coordinated for further pretrial
purposes but are individual lawsuits. As anticipated and
previously disclosed, as a result of the denial of class
certification by Judge Bechtle, a large number of additional
plaintiffs have filed lawsuits alleging injuries caused by
spinal implants manufactured by the Company. To date,
approximately two thousand eight hundred (2,800) plaintiffs
have filed lawsuits against the Company, with a few also
naming as defendants various officers and directors of the
Company. Also, plaintiffs' lawyers have filed several
lawsuits involving approximately two thousand eight hundred
fifty (2,850) claimants alleging a conspiracy theory among
doctors, manufacturers (including the Company), hospitals,
teaching institutions, professional societies and others to
promote in violation of applicable law the use of spinal
implants. Some plaintiffs have filed individual lawsuits,
whereas other lawsuits list multiple plaintiffs or in certain
instances multiple lawsuits have been filed on behalf of the
same individual plaintiffs. On August 22, 1996, Judge Bechtle
dismissed without prejudice plaintiffs' conspiracy claims.
The Company anticipates that most plaintiffs asserting these
conspiracy claims will file amended or new complaints, but it
is not possible at this time to estimate precisely how many of
these conspiracy complaints will be reasserted or the number
of additional plaintiffs that may file lawsuits.
21
<PAGE> 22
The majority of such lawsuits were filed in federal courts
throughout the country and are in the preliminary stages.
Discovery proceedings, including the taking of depositions,
have been ongoing in certain of the lawsuits that were first
to be filed. Discovery in certain cases filed later may begin
in the fourth quarter of this year. A number of the
plaintiffs are having their lawsuits returned to the state
court in Memphis, Tennessee. It is anticipated that the
Memphis, Tennessee state court judge will establish a schedule
for case management and discovery. The trials of a number of
lawsuits involving individual plaintiffs are scheduled to
begin in the first six months of 1997, although delays in
trial dates are common. Although plaintiffs have advanced
claims under many different legal theories, the essence of
plaintiffs' claims appears to be that the Company (including
Sofamor and its former U.S. distributor) marketed some of its
spinal systems for pedicle fixation in contravention of FDA
rules and regulations (governing marketing and labeling), that
pedicle fixation has not been proven safe and efficacious in
the context of FDA labeling standards and that plaintiffs have
suffered a variety of injuries as a result of the use of the
systems for pedicle fixation. Plaintiffs in these cases
typically seek relief in the form of monetary damages, often
in unspecified amounts. Many of the plaintiffs only allege as
monetary damages an amount in excess of the jurisdictional
minimum for the courts in which such cases are filed.
On April 8, 1996, Judge Bechtle issued a ruling that would
have resulted in the dismissal of many of the claims existing
against the Company in the multidistrict litigation. Judge
Bechtle's ruling granted defendant AcroMed Corporation's
motion for summary judgment on claims involving failure to
warn, manufacturing, design and testing defects, implied
warranty, negligence and defect per se. (AcroMed Corporation
is a spinal implant manufacturer and a defendant in various of
the cases pending in the multidistrict litigation). The Court
held that under applicable Third Circuit precedent, all of
these claims were expressly preempted by the medical device
provisions of the Food, Drug and Cosmetic Act ("FDCA"). The
Court's ruling left only claims for breach of express warranty
and unlawful promotion (excluding device labeling) as a basis
for a federal court lawsuit involving spinal implants. The
Court further provided that plaintiffs may seek reinstatement
of some or all of the dismissed claims if the U.S. Supreme
Court's decision in Lohr v. Medtronics altered the existing
Third Circuit law on federal preemption. On June 26, 1996,
the Supreme Court ruled in Lohr v. Medtronics that the
preemption provision contained in the medical device
amendments of the FDCA does not expressly preempt state tort
causes of actions. On the basis of this decision the
plaintiffs have sought reinstatement of all claims previously
dismissed by Judge Bechtle's April 8, 1996 ruling and the
Company expects that those claims will be reinstated. The
ruling in Lohr v. Medtronics also applies to all pending state
court cases.
22
<PAGE> 23
Tennessee and Oregon Product Liability Actions:
In January 1995, the Company and other spinal implant
manufacturers, doctors and a hospital were named defendants in
a purported class action product liability lawsuit filed in
Nashville, Tennessee state court. This lawsuit is limited to
those individuals whose surgeries were performed at one
specific hospital. Class certification has been denied by the
trial judge in Nashville. Discovery has only recently begun
in these individual cases. In October 1995, the Company was
served with a Portland, Oregon state court complaint that
purported to be a class action. This Oregon complaint alleged,
among other things, injury based upon various legal theories.
In March 1996, the plaintiffs in this Oregon case withdrew the
class allegations. Discovery has begun in these individual
cases. In these Tennessee and Oregon actions, plaintiffs, who
seek relief in the form of monetary damages of unspecified
amounts, are continuing their lawsuits as individual cases.
The Company believes that all product liability lawsuits
currently pending against it are without merit and will
continue to defend them vigorously. All pending cases are
currently being defended by insurance carriers, generally
under reservation of rights. 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.
While the aggregate monetary damages eventually sought by all
of these plaintiffs and the related costs to defend such
actions may be substantial and could exceed the limits of the
Company's various insurance policies, the Company believes
that it has affirmative defenses, including, without
limitation, defenses based upon the expiration of the
applicable statute of limitations, the learned intermediary
defense and 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
Company has and will continue to assert the affirmative
defenses primarily through the filing of dispositive motions.
As noted above, the Company also believes that all of these
individual lawsuits are without merit.
SECURITIES LAWS ACTIONS
Beginning in April 1994, the Company and four of its officers
and directors were named in five shareholder lawsuits filed in
Federal District Court in Memphis, Tennessee. Four of the
lawsuits purport to be class actions. All of the lawsuits
have been consolidated into one case in Federal 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
state material facts
23
<PAGE> 24
to the investing public and seeks money damages. The alleged
securities law violations are premised 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 Federal 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 Federal District
Court Judge in Memphis dismissed with prejudice the entire
case against the Company and each of the individual
defendants. The plaintiffs have appealed the dismissal, and
oral arguments relating to this appeal were heard on October
22, 1996 by the United Stated Court of Appeals for the Sixth
Circuit.
SPANISH DISTRIBUTOR ACTION
In late September 1994, a Magistrate of the Commercial Court
in Paris ruled in favor of a former Spanish distributor of
Sofamor's products on a claim of wrongful termination of the
distribution agreement in 1992. Prior to the Combination, an
accrual was established, with a related charge to earnings,
for this pending litigation. On the Combination date in June
1993, the Company also established a separate indemnity with
respect to potential losses resulting from such lawsuit and
placed in escrow shares issued to the former Sofamor
shareholders pending the 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 and the former distributor have
each appealed this ruling. The appeal process requires a
retrial of all issues and is currently scheduled for the
fourth quarter of 1997.
The Company does not believe that any pending litigation,
including the actions described above, will have a material
adverse effect on its consolidated financial position, results
of operations or cash flows because of, among other reasons,
the facts and circumstances existing with respect to each
action, the Company's belief that certain actions are without
merit, certain defenses available to the Company and the
availability of insurance in certain actions. (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.")
24
<PAGE> 25
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibit No. Description Page
----------- ----------- ----
27 Financial Data Schedule (For SEC use only) 27
b) Reports on Form 8-K
- None
25
<PAGE> 26
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, 1996 BY: /s/ E. R. Pickard
----------------- ------------------------------
E.R. Pickard
Chairman, Chief Executive Officer
and Director
(Principal Executive Officer)
DATE: November 12, 1996 BY: /s/ Laurence Y. Fairey
----------------- ------------------------------
Laurence Y. Fairey
Executive Vice President
and Chief Financial Officer
(Principal Financial Officer)
26
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF SOFAMOR DANEK FOR THE NINE MONTHS ENDED SEPTEMBER 30,
1996, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 6,315
<SECURITIES> 113
<RECEIVABLES> 60,797
<ALLOWANCES> 1,461
<INVENTORY> 44,742
<CURRENT-ASSETS> 139,802
<PP&E> 43,678
<DEPRECIATION> 18,963
<TOTAL-ASSETS> 267,280
<CURRENT-LIABILITIES> 93,437
<BONDS> 12,293
0
0
<COMMON> 52,316
<OTHER-SE> 107,395
<TOTAL-LIABILITY-AND-EQUITY> 267,280
<SALES> 174,244
<TOTAL-REVENUES> 174,244
<CGS> 30,710
<TOTAL-COSTS> 30,710
<OTHER-EXPENSES> 11,824
<LOSS-PROVISION> 403
<INTEREST-EXPENSE> 2,691
<INCOME-PRETAX> 46,361
<INCOME-TAX> 13,224
<INCOME-CONTINUING> 31,842
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 31,842
<EPS-PRIMARY> 1.22
<EPS-DILUTED> 1.22
</TABLE>
