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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, 1998
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number: 000-19168
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Sofamor Danek Group, Inc.
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(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Indiana 35-1580052
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(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification Number)
</TABLE>
1800 Pyramid Place, Memphis, Tennessee 38132
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(Address of principal executive offices) (Zip Code)
(901) 396-2695
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(Registrant's telephone number, including area code)
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(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.
26,913,994 shares of common stock outstanding as of September 30, 1998
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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,
1998 1997
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ASSETS (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 70,132 $ 2,729
Short-term investments 9,535 36
Accounts receivable--trade, less allowance for
doubtful accounts of $2,395 and $1,812 at
September 30, 1998 and December 31, 1997,
respectively 108,027 88,209
Other receivables 36,070 29,374
Inventories 48,892 40,575
Loaner set inventories 26,517 21,511
Prepaid expenses 6,321 6,061
Prepaid income taxes 12,337 3,052
Current deferred income taxes 13,239 8,013
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Total current assets 331,070 199,560
Property, plant and equipment
Land 1,498 1,477
Buildings 11,593 10,905
Machinery and equipment 44,155 35,677
Automobiles 1,058 759
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58,304 48,818
Less accumulated depreciation (28,372) (23,797)
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29,932 25,021
Investments 1,397 954
Intangible assets, net 103,803 97,048
Other assets 33,225 31,649
Non-current deferred income taxes 42,955 31,425
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Total assets $ 542,382 $ 385,657
========= =========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
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SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(IN THOUSANDS, EXCEPT SHARES)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
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LIABILITIES (UNAUDITED)
<S> <C> <C>
Current liabilities:
Notes payable and lines of credit $ 17,522 $ 11,731
Current maturities of long-term debt 563 7,586
Current portion of product liability litigation 14,500 8,606
Accounts payable 8,909 4,684
Income taxes payable 26,098 2,473
Accrued expenses 48,275 41,488
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Total current liabilities 115,867 76,568
Long-term debt, less current maturities 18,067 60,650
Product liability litigation, less current portion 14,745 33,970
Other long-term liabilities 25,794 --
Minority interest 5,572 3,171
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; 30,937,174 and 25,867,749 shares
issued (including 4,023,180 and 685,908 shares
held in treasury) at September 30, 1998 and
December 31, 1997, respectively 381,167 74,014
Retained earnings 184,051 154,828
Accumulated other comprehensive loss (1,426) (4,294)
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563,792 224,548
Less:
Cost of common stock held in treasury (198,190) (9,985)
Stockholder notes receivable (3,265) (3,265)
--------- ---------
Total stockholders' equity 362,337 211,298
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Total liabilities and stockholders' equity $ 542,382 $ 385,657
========= =========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
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SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues $ 101,846 $ 78,006 $ 283,683 $ 221,378
Cost of goods sold 20,044 14,631 51,631 39,661
--------- --------- --------- ---------
Gross profit 81,802 63,375 232,052 181,717
Operating expenses:
Selling, general and administrative 45,410 35,321 129,353 102,652
Research and development 7,206 4,822 20,596 14,319
Special charges -- -- 37,047 --
--------- --------- --------- ---------
52,616 40,143 186,996 116,971
--------- --------- --------- ---------
Income from operations 29,186 23,232 45,056 64,746
Other income (expense) 589 (23) 1,263 232
Interest expense (1,184) (1,530) (2,989) (4,221)
--------- --------- --------- ---------
Income from operations before
income taxes and minority interest 28,591 21,679 43,330 60,757
Income taxes 8,720 6,613 11,553 17,946
--------- --------- --------- ---------
Income before minority interest 19,871 15,066 31,777 42,811
Minority interest 1,127 662 2,554 1,980
--------- --------- --------- ---------
Net income $ 18,744 $ 14,404 $ 29,223 $ 40,831
========= ========= ========= =========
Net income per share - diluted $ 0.64 $ 0.54 $ 1.02 $ 1.54
========= ========= ========= =========
Net income per share - basic $ 0.70 $ 0.58 $ 1.11 $ 1.65
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
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SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
1998 1997
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<S> <C> <C>
Cash flows from operating activities:
Net income $ 29,223 $ 40,831
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Special charges 37,047 --
Depreciation and amortization 12,915 12,363
Provision for doubtful accounts receivable 562 393
Deferred income taxes (16,486) 556
Loss (gain) on disposal of equipment (196) 11
Equity (income) loss in unconsolidated affiliate -- (108)
Minority interest 2,554 1,980
Changes in assets and liabilities:
Accounts receivable (19,260) (10,386)
Other receivables (6,324) (9,342)
Inventories and loaner set inventories (12,843) (22,090)
Prepaid expenses (158) 1,759
Prepaid income taxes (9,273) (8,498)
Other assets (1,557) (3,960)
Accounts payable 3,990 (1,112)
Accrued income taxes 10,370 (753)
Accrued expenses (5,093) (907)
Product liability litigation (13,246) (4,901)
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Net cash provided by (used by) operating activities 12,225 (4,164)
-------- --------
Cash flows from investing activities:
Purchase of short-term investments (9,498) (2)
Proceeds from maturities of short-term investments 6 33
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
5
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SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
1998 1997
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<S> <C> <C>
Payments for purchase of property, plant and equipment (10,409) $ (6,055)
Proceeds from sale of equipment 994 404
Purchase of intangible assets (13,175) (14,471)
Increase in notes receivable, other (4,700) (844)
Repayments of notes receivable, other 4,423 56
Payments for investment (390) (341)
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Net cash used by investing activities (32,749) (21,220)
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Cash flows from financing activities:
Increase in short-term borrowings 5,642 28,799
Proceeds from long-term debt 42,134 174
Repayment of long-term debt and other obligations (91,755) (16,250)
Proceeds from issuance of common stock 133,637 15,398
Cash paid in the SOFYC exchange (1,930) --
Capital contribution by minority shareholder -- 148
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Net cash provided by financing activities 87,728 28,269
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Effect of exchange rate changes on cash 199 (162)
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Increase in cash and cash equivalents 67,403 2,723
Cash and cash equivalents, beginning of period 2,729 2,830
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Cash and cash equivalents, end of period $ 70,132 $ 5,553
========= ========
</TABLE>
Supplemental disclosure of non-cash financing activity:
- During July, 1997, the Company renegotiated its $80,000
uncollateralized revolving line of credit. The revision extended
maturity of this instrument to July 2000. As a result of this
renegotiation, $65,028 was reclassified from a current liability to a
long-term liability. This transaction is excluded from the above
statements of cash flows.
The accompanying notes are an integral part of the
consolidated financial statements.
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SOFAMOR DANEK GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Financial Statement Presentation
The consolidated financial statements of Sofamor Danek Group, Inc. (the
"Company") include the accounts of the Company and its subsidiaries over
which it maintains control. The consolidated balance sheet as of September
30, 1998 and the consolidated statements of income and consolidated
statements of cash flows for the periods ended September 30, 1998 and
1997, 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 amounts for prior periods have been reclassified to
conform with the presentation at September 30, 1998.
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 1997
Annual Report on Form 10-K.
2. Special Charges
During June 1998, the Company announced two strategic development and
licensing agreements under which it acquired exclusive worldwide rights to
new technology. In connection with these agreements, the Company recorded
special charges of $37.0 million, representing the estimated present value
of contractual payments to be made during the development and
commercialization of these new technologies.
In an agreement with Emory University ("Emory"), the Company acquired
rights to provide proprietary biological products for use in bone growth,
regeneration or repair and gene therapy applications. Upon the signing of
this agreement, the Company paid Emory $4.0 million. Under the terms of
this agreement, the Company also recorded a liability of $19.5 million
which is expected to be disbursed throughout the development cycle. The
Company will also pay Emory royalties on eventual product sales to
customers. In order to market this product in the United States, clearance
by the Food and Drug Administration ("FDA") will be necessary, which will
require several years of clinical trials.
In an agreement with Advanced Neuromodulation Systems, Inc. ("ANS"), the
Company acquired rights to use, market and sell products and systems for
use in Deep Brain Stimulation ("DBS"). DBS products provide electrical
stimulation to certain areas of the brain and are intended to relieve the
effects of various neurological disorders, such as Parkinson's Disease and
Essential Tremor. The Company believes that the use of DBS can be expanded
by combining DBS with the Company's existing StealthStation(TM)
technology. Upon the signing of this agreement, the Company paid ANS $4.0
million. Under the terms
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of this agreement, the Company also recorded a liability of $9.5 million
that is expected to be paid throughout the development cycle. ANS will
also receive royalties when the Company ultimately sells the product to
customers. In order to market the products in the United States, FDA
clearance will be necessary, which will require clinical trials.
3. Inventories and Loaner Set Inventories
Net inventories and loaner set inventories consist of the following (in
thousands):
<TABLE>
<CAPTION>
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September 30, 1998 December 31, 1997
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<S> <C> <C>
Finished goods $41,417 $35,029
Work-in-process 4,771 3,405
Raw materials 2,704 2,141
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Net inventories $48,892 $40,575
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Loaner set inventories, net $26,517 $21,511
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</TABLE>
4. Income Taxes
The Company's effective income tax rate for the third quarter of 1998 was
30.5%, equal to the rate for the prior year third quarter. The difference
between the Company's effective and statutory tax rates for both 1998 and
1997 resulted primarily from the impact of certain elections made for U.S.
tax purposes following the combination (the "Combination") of Danek Group,
Inc. with Sofamor S.A. ("Sofamor"), and the subsequent reorganization of
Sofamor from a Societe Anonyme (S.A.) under French law to a Societe en Nom
Collectif (S.N.C.) in late 1993. Management cannot be certain that such a
favorable effective income tax rate will be achieved in future periods,
since the effective tax rate calculation is dependent upon the Company's
pre-tax income dollar amount. Higher future pre-tax income could lead to
higher future effective tax rates. At September 30, 1998, the balance
sheet of the Company reflected a net deferred tax asset of $56.2 million.
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 1998 and 1997, charges in lieu of income
taxes of $8.8 million and $5.6 million, respectively, were recorded by the
Company as a result of certain common stock options being exercised.
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5. Net Income Per Common Share
The Company computes its earnings per share ("EPS") in accordance with
Statement of Financial Accounting Standard ("SFAS") No. 128. Basic EPS
excludes dilution and is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding
for the period. Diluted EPS reflects the potential dilution that could
occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity.
Potential common stock in the form of stock options have an effect on the
diluted net income per common share calculations for the periods ended
September 30, 1998 and 1997. Potential common stock also includes assumed
converted debt securities. In computing diluted EPS, net income is
adjusted by the amount of interest expense, net of taxes, from convertible
debt which is assumed to have been converted for the diluted weighted
average number of shares calculation.
The following table presents information necessary to calculate diluted
EPS for the periods ended September 30, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
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THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
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<S> <C> <C> <C> <C>
Weighted average shares
outstanding - Basic 26,822 24,898 26,281 24,695
Shares equivalents 2,490 1,979 2,535 1,872
--------------------------------------------------------------------------------------
Weighted average shares
outstanding - Diluted 29,312 26,877 28,816 26,567
--------------------------------------------------------------------------------------
</TABLE>
6. Comprehensive Income
As of January 1, 1998, the Company adopted the provisions of SFAS No. 130,
"Reporting Comprehensive Income," which establishes standards for the
reporting and display of comprehensive income and its components within
financial statements. The adoption of this statement had no impact on the
Company's net income or stockholders' equity. Comprehensive income
consists of all changes, including net income, in the Company's equity
during a period, except those resulting from investments by, or
distributions to, the Company's stockholders.
Components of comprehensive income, net of related tax, for the periods
ended September 30, 1998 and 1997, are as follows (in thousands):
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<TABLE>
<CAPTION>
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THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $18,744 $14,404 $29,223 $40,831
Foreign currency translation
adjustment 3,321 (140) 2,868 (4,515)
- ----------------------------------------------------------------------------------------
Comprehensive income $22,065 $14,264 $32,091 $36,316
- ----------------------------------------------------------------------------------------
</TABLE>
7. Stock Exchange and Public Offering
On January 26, 1998, the Company purchased all of the outstanding capital
stock of SOFYC, S.A. ("SOFYC") for an aggregate of 2,806,080 privately
placed shares of the Company's common stock, $1.0 million in cash (less
certain expenses relating to the repurchase) and an agreement to repay
certain outstanding loans of SOFYC equal to approximately $0.9 million
(the "SOFYC Exchange"). In connection with the SOFYC Exchange, a foreign
tax liability of $13.0 million was reflected at September 30, 1998, which
represents an estimate of the tax the Company will incur upon retiring the
shares owned by SOFYC. SOFYC, which was the personal holding company of
the Cotrel family, owns 3,337,272 shares of the Company's Common Stock. As
a result of the SOFYC Exchange, the outstanding shares of common stock of
the Company were reduced by 531,192 shares. In connection with the
transaction, certain registration rights were granted to the former SOFYC
shareholders. In accordance with these rights, the Company filed a
registration statement with the Securities and Exchange Commission related
to a public offering on behalf of the former SOFYC shareholders of
1,600,000 of their 3,689,711 shares of Sofamor Danek common stock that
they owned in aggregate. The registration also provided for a public
offering of up to 1,200,000 shares of common stock to be sold by the
Company for its own account. In addition, Sofamor Danek granted to the
underwriters a maximum over-allotment option of 420,000 shares of common
stock. The over-allotment option was exercised. The net proceeds received
by the Company pursuant to the offering totaled $110.1 million. These
proceeds were invested in cash equivalents and short-term investments that
are carried at historical cost, which approximates fair value due to the
short maturities of the securities.
8. Commitments and Contingencies
The Company is involved from time to time in litigation on various matters
which include intellectual property, commercial affairs and product
liability. Given the nature of the Company's business activities, these
lawsuits are considered routine to the conduct of its business. The result
of any particular lawsuit cannot, because, among other things, of the very
nature of litigation, the litigation process and its adversarial nature,
and the jury system, be predicted.
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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 FDA rules and regulations (governing marketing and labeling of medical
devices), that pedicle fixation has not been proven safe and effective in
the context of FDA labeling standards, that some or all of the spinal
systems are defectively designed and manufactured and that plaintiffs have
suffered a variety of injuries as a result of their physicians' use of
such systems in pedicle fixation. The Company has also been named as a
defendant in a number of lawsuits instituted by plaintiffs who have
received spinal implants manufactured by other manufacturers and in which
the Company is alleged to have participated in a conspiracy among doctors,
manufacturers, hospitals, teaching institutions, professional societies
and others to promote, in violation of applicable law, the use of spinal
implants.
In a number of cases, plaintiffs have sought to proceed as representatives
of classes of spinal implant recipients. All efforts to obtain class
certification have been denied or withdrawn, except with respect to a
class-action settlement entered into between the plaintiffs and another
spinal implant manufacturer, AcroMed Corporation ("Acromed") (see below
under the heading entitled "AcroMed Corporation Settlement"). Some
plaintiffs have filed individual lawsuits, whereas other lawsuits list
multiple plaintiffs and, in certain instances, multiple lawsuits have been
filed on behalf of the same individual plaintiffs. Plaintiffs typically
seek relief in the form of monetary damages, often in unspecified amounts.
Many of the plaintiffs only allege as monetary 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.
Since the litigation began, over 1,000 plaintiffs have been dismissed. As
of September 30, 1998, the claims of approximately 2,100 plaintiffs who
received a product made by the Company remain active in litigation
against the Company. The majority of these plaintiffs filed their claims
in 1995. Of these, approximately 800 are in federal courts, and
approximately 1,300 are in state courts. The Company is also named as a
defendant in lawsuits involving about 1,950 plaintiffs (230 federal, 1,720
state) where the Company is alleged to have conspired with competitors and
others, in violation of applicable law, to promote the use of spinal
implant systems.
The Company believes that it has meritorious defenses to these claims,
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. As of
September 30, 1998, the Company has been awarded summary judgment in 42
cases and partial summary judgment in three cases. It has been denied
summary judgment in three cases, and has 83 motions for summary judgment
pending. The Company believes that all product liability lawsuits
currently pending against it are without merit and it will continue to
defend against them vigorously.
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FEDERAL MULTIDISTRICT LITIGATION (MDL 1014)
On August 4, 1994, the Federal Judicial Panel on Multidistrict Litigation
ordered all federal court lawsuits to be transferred to and consolidated
for pretrial proceedings, including the determination of class
certification, in the United States District Court for the 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 ("Judge 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. On April 16, 1997, Judge Bechtle
dismissed all conspiracy claims alleging fraud on the FDA. On August 13,
1998, 870 conspiracy claims pending in the Multidistrict Litigation were
dismissed. (The dismissal of these conspiracy claims is on appeal.) As of
September 30, 1998, the Company remains a defendant in approximately 550
individual claims and 130 conspiracy claims still consolidated in the
Multidistrict Litigation.
FEDERAL REMANDED CASES
Discovery has been completed in most of the federal court cases and is
continuing in those that remain. Judge Bechtle has initiated the process
of transferring or remanding the federal court cases to various federal
courts throughout the United States. As of September 30, 1998, the Federal
Judicial Panel on Multidistrict Litigation has ordered the remand of more
than 300 cases to transferor courts for further proceedings. Cases
involving more than 90 plaintiffs are currently pending remand. It is
expected that the 550 remaining individual cases against the Company in
the Multidistrict Litigation will be remanded over the next several
months. The first federal court cases have been scheduled for trial in
1998, although these dates often change.
STATE COURT LITIGATION
As of September 30, 1998, there were approximately 1,300 individual claims
pending against the Company in several state courts around the country,
principally in Tennessee, Oklahoma, Texas and Pennsylvania. In additional,
there were approximately 1,700 conspiracy claims pending in state courts.
Of these individual claims, the lawsuits of approximately 1,100 plaintiffs
are pending in Memphis, Tennessee. The presiding state court judge in
Memphis established a case management plan, which selected eight
representative cases for preparation and trial. Summary judgment in favor
of the Company has been granted in seven of the eight representative
cases. Those summary judgment decisions are on appeal. A motion for
summary judgment is pending in the remaining representative case in
Memphis against the Company.
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Discovery is proceeding in all remaining state court cases. A number of
other state court cases around the country have been scheduled for trial
in 1998, although delays in trial dates are common. In May, 1998, a jury
in Houston, Texas rendered a verdict adverse to the Company in the amount
of $0.4 million. The Company does not believe that that verdict was
justified by the evidence and has appealed.
ACROMED CORPORATION SETTLEMENT
In December 1996, AcroMed, a spinal implant manufacturer and a defendant
in many of the cases pending in the Multidistrict Litigation, and the
Plaintiffs' Legal Committee in the Multidistrict Litigation announced that
they had entered into a conditional settlement regarding all product
liability claims involving the use of AcroMed devices to achieve pedicular
fixation with screws in spinal fusion surgery. Under the terms of the
settlement, AcroMed has established a settlement fund consisting of $100.0
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 appeals of
Judge Bechtle's certification and approval order have been withdrawn.
INSURANCE
Several insurance carriers have asserted reservation of rights concerning
the scope and timing of the Company's insurance coverage available in
connection with product liability litigation, but have not denied
insurance coverage to the Company. Three of the carriers, Royal Surplus
Lines Insurance Company ("Royal"), Steadfast Insurance Company
("Steadfast") and Agricultural Excess and Surplus Insurance Company
("Agricultural"), have each filed declaratory judgment actions against the
Company seeking clarification of their rights and obligations, if any,
under their respective policies. Neither Royal nor Agricultural has paid
amounts due to the Company. Steadfast has paid only a portion of the
amounts due to the Company.
The Royal, Steadfast and Agricultural lawsuits are pending in the United
States District Court for the Western District of Tennessee in Memphis.
The Company believes that its
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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. In the Royal litigation a motion seeking the interim
payment of the Company's defense costs was denied, but the court has
scheduled a further hearing to determine whether the motion may be granted
with respect to specific claims asserted against the Company. The Company
has filed answers and counterclaims in the Steadfast litigation and
intends to file answers and counterclaims in the Agricultural litigation.
The Company believes that Royal's, Steadfast's and Agricultural's claims
are without merit and will defend against them vigorously.
As is common in the insurance industry, the Company's insurance policies
covering product liability claims must be renewed annually. The Company
has in force insurance coverage for product liability claims including
orthopedic bone screw claims, subject to the terms, conditions and limits
of the individual insurance policies. Except for a policy issued by Royal,
the Company's insurance policies are reduced by the costs of defense. In
some instances, the cost of defending these claims has been reimbursed by
certain of the primary and excess insurance carriers. Although the Company
has been able to obtain insurance relating to product liability claims at
a cost and on other terms and conditions that are acceptable to the
Company, there can be no assurance that in the future it will be able to
do so.
On January 6, 1997, the Company announced that its 1996 financial results
would include a pre-tax charge of $50.0 million relating to costs
associated with the product liability litigation described above. The
charge, which was reflected in the Company's 1996 financial statements,
covers the reasonable foreseeable costs that the Company was positioned in
late December 1996 to estimate because the litigation had progressed and
because changes in the fourth quarter of 1996 had occurred in facts and
circumstances relating to the litigation. Among the changed facts and
circumstances were the announcement of the AcroMed settlement described
above, the likelihood that the litigation will continue for several years,
in part, due to the additional financial resources provided to the
plaintiffs' attorneys as a result of the AcroMed settlement, the absence
of AcroMed as a member of the joint defense group, the status of the
Company's insurance described above and the continuing absence of
dispositive rulings relating to the Company's defense motions.
While it is not possible to accurately predict the outcome of litigation,
the amount of the accrual, which remained on the Company's consolidated
balance sheet at September 30, 1998, represents the Company's best
judgment of the probable reasonable costs (in excess of the amount of
insurance the Company believes is recoverable) to defend and conclude the
lawsuits based on the facts and circumstances currently existing. The
costs provided for in the accrued liability include, but are not limited
to, legal fees paid or anticipated to be paid and other costs related to
the Company's defense and conclusion of these matters.
The actual costs to the Company could differ from the estimated charge and
will be dependent upon a number of factors that will not be known for some
time, including, among other things, the resolution of defense motions and
the extent of further discovery. Although an adverse resolution of
lawsuits could have a material effect on the Company's results of
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<PAGE> 15
operations and cash flows in future periods, the Company does not believe
that these matters will in the future have a material adverse effect on
its consolidated financial position. The Company is unable to predict the
ultimate outcome or the financial impact of the product liability
litigation.
SECURITIES LAWS ACTIONS
Beginning in April 1994, the Company and four of its officers and
directors were named in five shareholder lawsuits filed in the United
States District Court in Memphis, Tennessee. Four of the lawsuits
purported to be class actions. All of the lawsuits were consolidated into
one case in the United States District Court in Memphis through an amended
complaint which added four new individual defendants who are either
current or former directors of the Company. The lawsuit alleged that the
defendants made false and misleading statements and failed to disclose
material facts to the investing public and sought money damages. The
alleged securities law violations were 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 U.S. distributor of Sofamor
products, National Medical Specialties, Inc. 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.
On August 14, 1997, the Court of Appeals for the Sixth Circuit affirmed
the dismissal of the plaintiffs' complaint. On May 4, 1998 the United
States Supreme Court declined to review the plaintiffs' case. The
dismissal of the plaintiffs' case is now final.
INTERNAL REVENUE SERVICE DOCUMENT PRODUCTION
On April 29, 1998, the Internal Revenue Service (the "IRS") served the
Company with a summons covering the 1993, 1994 and 1995 taxable years.
Generally, the IRS is requiring the production of (i) documents supporting
expenses incurred in connection with trips attended by physicians, (ii)
documents relating to payments made to physicians for
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<PAGE> 16
consulting, (iii) documents relating to stock options granted, royalty
agreements and payments, fellowship grants/awards, scholarships and
honorariums, (iv) a list of Company customers, (v) certain revenue
information and (vi) a report with respect to governmental customers. The
Company is cooperating fully with the IRS in this matter.
9. Subsequent Event
On November 1, 1998, the Company entered into an Agreement and Plan of
Merger (the "Merger Agreement") with Medtronic, Inc., a Minnesota
corporation ("Medtronic"), and MSD Merger Corp., an Indiana corporation
and wholly owned subsidiary of Medtronic ("Merger Subsidiary"), pursuant
to which Medtronic will acquire the Company. Subject to the terms and
conditions of the Merger Agreement, Merger Subsidiary will be merged with
and into the Company (the "Merger") at the effective time of the Merger
and the Company will become a wholly owned subsidiary of Medtronic. At the
effective time of the Merger, each then outstanding share of Company
common stock, other than shares to be cancelled in accordance with the
Merger Agreement, will be converted into the right to receive shares of
Medtronic common stock having a value of $115, as calculated in accordance
with the Merger Agreement and subject to certain adjustments for certain
changes in the average closing sales price of Medtronic common stock
during a period prior to the vote of the Company's shareholders on the
Merger. The Merger is subject to Company shareholder approval, regulatory
approvals and other customary closing conditions. The transaction,
expected to be completed in early 1999, will be accounted for as a
tax-free pooling of interests.
Also on November 1, 1998, the Company entered into a Stock Option
Agreement with Medtronic pursuant to which the Company granted an option
to Medtronic to purchase up to 5,366,478 shares of Company common stock at
a price of $115 per share upon the occurrence of certain events related to
termination of the Merger Agreement.
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<PAGE> 17
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, excluding special charges, expressed as a percentage of
revenues and the period-to-period change in such information:
<TABLE>
<CAPTION>
PERIOD-TO-PERIOD CHANGE
--------------------------------
THREE MONTHS NINE MONTHS
SEPTEMBER 30, SEPTEMBER 30,
THREE MONTHS NINE MONTHS 1998 1998
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, VS VS
1998 1997 1998 1997 1997 1997
------ ------ ------ ------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Revenues 100.0% 100.0% 100.0% 100.0% 30.6% 28.1%
Cost of goods sold 19.7 18.8 18.2 17.9 37.0 30.2
------ ------ ------ -------
Gross profit 80.3 81.2 81.8 82.1 29.1 27.7
Operating expenses:
Selling, general and administrative 44.5 45.2 45.6 46.4 28.6 26.0
Research and development 7.1 6.2 7.3 6.5 49.4 43.8
------ ------ ------ -------
Total operating expenses 51.6 51.4 52.9 52.9 31.1 28.2
Income from operations 28.7 29.8 28.9 29.2 25.6 26.8
Other income 0.6 -- 0.4 0.1 N/M N/M
Interest expense (1.2) (2.0) (1.0) (1.9) (22.6) (29.2)
------ ------ ------ -------
Income from operations before income
taxes and minority interest 28.1 27.8 28.3 27.4 31.9 32.3
Income taxes 8.6 8.5 8.6 8.1 31.9 36.6
------ ------ ------ -------
Income before minority interest 19.5 19.3 19.7 19.3 31.9 30.5
Minority interest 1.1 0.8 0.9 0.9 70.2 29.0
------ ------ ------ -------
Net income 18.4% 18.5% 18.8% 18.4% 30.1% 30.5%
====== ====== ====== =======
</TABLE>
RESULTS OF OPERATIONS*
For the third quarter and nine months ended September 30, 1998, the Company
reported record revenues of $101.8 million and $283.7 million, respectively,
representing increases of 30.6% and 28.1% over the respective prior year
periods. For the quarter, volume growth increased revenues by 32.4% and net
pricing changes contributed a 3.2% increase. These factors were offset by
changes in exchange rates, which negatively impacted third quarter revenues by
5.0%. For the nine month period, higher volume resulted in revenue growth of
29.4%, and pricing changes
- -------------
* 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, 1997 and the Current
Report on Form 8-K dated February 3, 1998) filed with the Securities and
Exchange Commission.
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<PAGE> 18
increased revenues by 3.8%. The negative impact of exchange rate fluctuations
for the nine month period was 5.1%.
U.S. revenues grew to $71.2 million for the quarter ended September 30, 1998, a
35.2% increase from the same period in 1997. For the nine month period, U.S.
revenues increased to $198.7 million, representing growth of 32.6% from the
prior year period. The Company believes the improvement in U.S. revenues is
primarily the result of an increased number of instrumented fusions. This growth
in the number of fusions has occurred, in part, due to the broad range of
quality products provided by the Company to assist physicians in treating their
patients.
Non-U.S. revenues advanced 20.9%, to $30.6 million, during third quarter 1998,
when compared to third quarter 1997. The increase would have been 36.3% if
exchange rates had been constant. For the nine month period, international
revenues increased to $85.0 million, an increase of 18.8% from 1997 levels.
Ignoring the effect of changes in exchange rates, international revenues would
have increased 34.7% over the prior year nine month period. Higher volume was
the primary source of the non-U.S. revenue growth in 1998 as compared with the
same period of 1997. Non-U.S. revenue growth has also resulted in part from
strengthening the Company's presence in key countries where direct sales
operations have been established in recent years.
The Company's gross margin of 80.3% during the third quarter of 1998 decreased
slightly from 81.2% for the same period of 1997. For the nine month period, the
1998 gross margin decreased 0.3 points to 81.8%. The decrease in margins
resulted primarily from third quarter 1998 low-margin sales of excess inventory
in certain international areas.
Selling, general and administrative expenses were 44.5% of revenues in the third
quarter of 1998, compared with 45.2% during the same period of 1997. For the
nine month period, these expenses represented 45.6% of revenues in 1998 versus
46.4% in 1997. Though total selling, general and administrative expenses have
increased as the Company continues its rapid growth, these expenses, expressed
as a percentage of revenues, have decreased as the Company has been able to
leverage certain of its fixed costs over a larger revenue base.
Research and development expenses totaled $7.2 million, or 7.1% of revenues, for
the third quarter of 1998, compared with $4.8 million, or 6.2% of revenues, for
the third quarter of 1997. For the nine month periods, these expenses totaled
$20.6 million and $14.3 million in 1998 and 1997, respectively. As a percentage
of revenues, research and development increased to 7.3% in 1998 from 6.5% in
1997. The third quarter 1998 dollar spending represents an increase of 49.4%
over the same period in 1997. These development and clinical costs are incurred
as the Company continues to enhance existing product lines and develop new and
complementary products, such 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 producing product
opportunities through the application of new medical technologies.
During June 1998, the Company announced two strategic development and licensing
agreements under which it acquired exclusive worldwide rights to new technology.
In connection with these
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<PAGE> 19
agreements, the Company recorded special charges of $37.0 million, representing
the estimated present value of contractual payments to be made during the
development and commercialization of these technologies. Under the first
agreement, with Emory, the Company acquired exclusive worldwide rights to
provide proprietary biological products for use in bone growth, regeneration or
repair and gene therapy applications. In order to market the products in the
United States, FDA clearance will be required, which will require several years
of clinical trials. Under the second agreement, with ANS, Sofamor Danek acquired
exclusive worldwide rights to use, market and sell products and systems for use
in the field of deep brain stimulation to certain areas of the brain. This
treatment is intended to relieve the effects of various neurological disorders,
such as Parkinson's Disease and Essential Tremor. In order to market the
products in the United States, FDA clearance will be necessary, which will
require clinical trials.
The Company reported other income of $0.6 million for the quarter ended
September 30, 1998, compared with a small expense for the same period in 1997.
For the nine month period, other income increased to $1.3 million in the current
year from $0.2 million in 1997. Improvements in both periods related principally
to higher interest income on cash equivalents and short term investments
purchased with proceeds from the first quarter public offering (see "Liquidity
and Capital Resources" section). Interest expense for the third quarter of 1998
was $1.2 million, compared with $1.5 million during the same period in 1997. For
the nine month period, interest expense was $3.0 million in 1998, compared with
expense of $4.2 million in 1997. These decreases were also related primarily to
the first quarter public offering, as the Company reduced its borrowings against
credit facilities in March of 1998 after receiving the proceeds of its public
offering. Partially offsetting the lower credit facility was the imputed
interest, beginning in July 1998, on the net present value of the accrued
contractual payments due under the Emory and ANS agreements.
The Company's effective income tax rate for third quarter 1998 was 30.5%, equal
to the rate for the prior year third quarter. Tax rates for the nine month
periods, excluding the impact of special charges, were 30.5% and 29.5% in 1998
and 1997, respectively. The primary difference between the Company's effective
and statutory tax rates for both 1998 and 1997 results from the impact of
certain elections made for U.S. tax purposes following the combination (the
"Combination") of Danek Group, Inc. with Sofamor S.A. ("Sofamor"), and the
subsequent reorganization of Sofamor from a Societe Anonyme (S.A.) under French
law to a Societe en Nom Collectif (S.N.C.) in late 1993. Management cannot be
certain that such a favorable effective income tax rate will be achieved in
future periods, since the effective tax rate calculation is dependent upon the
Company's pre-tax income dollar amount. Higher future pre-tax income could lead
to higher future effective tax rates. At September 30, 1998, the balance sheet
of the Company reflected a net deferred tax asset of $56.2 million. No valuation
allowance was recorded since sufficient taxable income exists in available
carryback periods to recognize fully these net deferred tax assets.
LIQUIDITY AND CAPITAL RESOURCES
On January 26, 1998, the Company purchased all of the outstanding capital stock
of SOFYC, S.A. ("SOFYC") for an aggregate of 2,806,080 privately placed shares
of the Company's
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<PAGE> 20
common stock, $1.0 million in cash (less certain expenses relating to the
repurchase) and an agreement to repay certain outstanding loans of SOFYC equal
to approximately $0.9 million (the "SOFYC Exchange"). In connection with the
SOFYC Exchange, a foreign tax liability of $13.0 million was reflected at
September 30, 1998, which represents an estimate of the tax the Company will
incur upon retiring the shares owned by SOFYC. SOFYC, which was the personal
holding company of the Cotrel family, owns 3,337,272 shares of the Company's
common Stock. As a result of the SOFYC Exchange, the outstanding shares of
common stock of the Company were reduced by a net 531,192 shares. In connection
with the transaction, certain registration rights were granted to the former
SOFYC shareholders. In accordance with these rights, the Company filed a
registration statement with the Securities and Exchange Commission related to a
public offering on behalf of the former SOFYC shareholders of 1,600,000 of their
3,689,711 shares of Sofamor Danek common stock that they owned in the aggregate
before the offering. The registration statement also provided for a public
offering of up to 1,200,000 shares of common stock to be sold by the Company for
its own account. In addition, Sofamor Danek granted to the underwriters a
maximum over-allotment option of 420,000 shares of common stock. The over
allotment option was exercised. The Company issued 1,620,000 shares and received
net proceeds pursuant to the offering of $110.1 million. The Company invested
these proceeds upon receipt and intends to use them for a variety of purposes as
needed, including the repayment of outstanding borrowings, research and product
development, capital expenditures, certain foreign taxes due in connection with
the SOFYC transaction, acquisitions and working capital.
Cash generated from operations and the Company's revolving lines of credit are
the principal ongoing 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 together with the proceeds from the
public offering mentioned above will be sufficient to meet its expected cash
needs for the foreseeable future. Cash, cash equivalents and short-term
investments totaled $79.7 million at September 30, 1998, compared with $2.8
million at December 31, 1997.
The Company's working capital increased by $92.2 million during the nine months
ended September 30, 1998. The increase in working capital resulted primarily
from the proceeds from the public offering, partially offset by the amounts used
to repay long-term debt. Accounts receivable increased $19.8 million, or 22.5%
from December 31, 1997, due to overall sales growth, combined with changes in
the sales mix, both by product type and by geographic area. Inventories and
loaner set inventories increased by $13.3 million or 21.5% from year-end, due in
part to the production of new inventory items in preparation for their
introduction, combined with increased demand for the Company's products. Working
capital was not significantly impacted by changes related to product liability
litigation. Other receivables, which consist primarily of amounts recoverable
from insurance carriers relating to the costs incurred in connection with
product liability litigation, and the current portion of product liability
litigation, representing the estimated payments to be made over the next year,
increased $6.7 million and $6.0 million respectively, practically offsetting one
another.
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<PAGE> 21
In connection with the Company's 1995 license agreement with Genetics
Institute, the Company paid $7.5 million during June 1998, representing the
final payment due under the agreement. Income taxes payable increased $23.6
million from year end. In addition to the $13.0 million accrual related to the
SOFYC transaction, taxes payable have increased due to higher income and timing
of estimated payments.
The purchase agreements for two 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 are reflected as purchase price
adjustments. The Company recorded adjustments to the purchase price of these
acquisitions of $5.1 million and $4.2 million in 1997 and 1996, respectively.
The amount recorded in 1996 was paid in April 1997, and the amount recorded in
1997 was paid in March 1998. The Company is unable to determine whether such
adjustments will be required for 1998 or 1999.
Additions to property, plant and equipment during the first nine months of 1998
were $10.4 million and related to capital asset expenditures necessary to
support the Company's manufacturing and distribution operations. As a result of
the Company's need of additional office and distribution space at its Memphis
location, management recently entered into an agreement under which the Company
is leasing a new facility adjacent to its existing headquarters. This lease has
an initial term of 10 years and is being accounted for as an operating lease.
The Company moved into the new facility during third quarter 1998.
The Company has committed lines of credit totaling approximately $130.0 million.
At September 30, 1998, $25.8 million was outstanding under these lines of credit
and other short-term borrowings. The committed lines of credit consist primarily
of the $100.0 million U.S. revolving lines of credit.
In 1996, the Internal Revenue Service began an examination of the Company's
federal income tax returns. The years under examination are 1993, 1994 and 1995.
Management believes that the resolution of any issues that may result from this
examination will not have a significant impact on the Company's results of
operations or financial condition. See Part II, Item 1, "Legal
Proceedings-Internal Revenue Service Document Production."
The Company invests available funds in short-term investment grade instruments,
including commercial paper, certificates of deposit and direct or guaranteed
obligations of state and local governments or the United States of America.
These short-term investments are available to fund the Company's working capital
requirements and acquisitions of capital assets.
PROPOSED MERGER
On November 1, 1998, the Company entered into an Agreement and Plan of Merger
(the "Merger Agreement") with Medtronic, Inc., a Minnesota corporation
("Medtronic"), and MSD Merger Corp., an Indiana corporation and wholly owned
subsidiary of Medtronic ("Merger Subsidiary"), pursuant to which Medtronic will
acquire the Company. Subject to the terms and conditions of the Merger
Agreement, Merger Subsidiary will be merged with and into the Company (the
"Merger") at the effective time of the Merger and the Company will become a
wholly owned subsidiary of Medtronic. At the effective time of the Merger, each
then outstanding share of Company common stock, other than shares to be
cancelled in accordance with the Merger Agreement, will be converted into the
right to receive shares of Medtronic common stock having a value of $115, as
calculated in accordance with the Merger Agreement and subject to certain
adjustments for certain changes in the average closing sales price of Medtronic
common stock during a period prior to the vote of the Company's shareholders on
the Merger. The Merger is subject to Company shareholder approval, regulatory
21
<PAGE> 22
approvals and other customary closing conditions. The transaction, expected to
be completed in early 1999, will be accounted for as a tax-free pooling of
interests.
Also on November 1, 1998, the Company entered into a Stock Option Agreement
with Medtronic pursuant to which the Company granted an option to Medtronic to
purchase up to 5,366,478 shares of Company common stock at a price of $115 per
share upon the occurrence of certain events related to termination of the
Merger Agreement.
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 and Compliance. The preclinical testing, manufacturing,
labeling, distribution and promotion of the Company's products are subject to
extensive government regulation by the FDA in the United States and comparable
regulatory bodies in other countries. Noncompliance with the applicable
regulatory requirements can lead to enforcement actions which may result in,
among other things, warning letters, fines, recalls or seizures of products,
total or partial suspension of production, refusal by governments to grant
pre-market clearances and criminal prosecution. 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 process will not involve delays adversely affecting the
marketing and sale of new devices. In the United States, even after regulatory
clearance or approval to market a device is obtained from the FDA, the Company
is subject to continuing FDA regulation. FDA approvals or clearances are
required for certain changes to the labeling and marketing of medical devices.
FDA regulations depend 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 is also subject to numerous federal, state and local laws relating
to such matters as safe working conditions, manufacturing practices and
environmental protection. There can be no assurance that the Company will not be
required to incur significant costs to comply with such laws and regulations.
Unanticipated changes in existing regulatory requirements, failure of the
Company to comply with such requirements or adoption of new requirements could
have a material adverse effect on the Company's business.
Potential Impact of Healthcare Cost Containment Proposals on Profitability.
Sales of a large portion of the Company's products depend to a significant
extent on the availability of reimbursement to the Company's customers by
government and private insurance plans. In recent years, the cost of healthcare
has risen significantly, and there have been numerous proposals by legislatures,
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 the ultimate
timing, scope or effect of any legislation concerning healthcare reform. Any
legislation, if adopted, could result in significant changes in the
availability, delivery, pricing and payment for healthcare services and products
and adversely affect the Company's business. In addition, hospitals and other
healthcare providers have become increasingly cost sensitive. To date, the
Company does not believe that such healthcare cost containment proposals have
negatively affected the profitability
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<PAGE> 23
or growth of its business; however, the Company is not able to predict the
future effect of these proposals on its business.
Rapid Technological Change; Technological Obsolescence; Acceptance Of New
Products. The medical device industry is characterized by rapidly changing
technology and frequent new product introductions. The Company's future success
will depend largely on the Company's ability to develop and introduce in a
timely manner new products and enhancements that meet changing customer
requirements and emerging industry standards. Although the Company's strategy
for growth includes the introduction of new products, the development of new
technologically advanced products and enhancements is a complex and uncertain
process requiring high levels of innovation as well as the anticipation of
technology and market trends. The Company may not be able to respond effectively
to technological changes, emerging industry standards or product announcements
by competitors, it may not be able to identify, develop, manufacture, market,
sell or support new products and enhancements successfully and its new products
or enhancements may not achieve market acceptance. Market acceptance for
products under development could be adversely affected by numerous factors,
including the lack of availability of third-party reimbursement to consumers of
such products, the cost of the products, clinical acceptance thereof and
effective physician training. Market acceptance will also depend on the
Company's ability to demonstrate that such products are an attractive
alternative to existing products, which will depend on physicians' evaluations
of the clinical safety and efficacy, ease of use, reliability and
cost-effectiveness of the products. Furthermore, the Company believes that, once
the products receive approval, recommendations and endorsements by influential
surgeons will be essential to market acceptance of its products. There can be no
assurance that the Company's products under development will adequately
demonstrate these characteristics or that they will receive market acceptance
among consumers or physicians. Any of these events could have a material adverse
effect on the Company's business, financial condition and results of operations.
Product Liability; Insurance. In recent years, physicians, hospitals, and other
participants in the healthcare industry have become subject to an increasing
number of lawsuits alleging malpractice, product liability or related legal
theories, many of which involve large claims and significant defense costs. The
Company is currently involved in product liability litigation. (See Note 8 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. The Company currently maintains liability insurance at
coverage levels which it deems commercially reasonable. Historically, the
Company has been required to call on its insurance for product liability claims,
and assuming all amounts are paid by the insurance carriers, the Company will
have exhausted its insurance coverage for the coverage year ended November 1995.
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
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<PAGE> 24
applicable policy (See Part II, Item 1, "Legal Proceedings -- Insurance"). Such
insurance is expensive, difficult to obtain and may not be available in the
future on acceptable terms or at all.
Increasing Competition. The medical device industry is subject to intense
competition. The market for products designed to treat spinal conditions is
highly competitive, and the Company expects competition to increase as a result
of new entrants and consolidations. Accordingly, the Company's future success
will depend in part on its ability to respond quickly to medical and
technological change and user preferences through the development and
introduction of new products that are of high quality and that address patient
and surgeon requirements and, in part, on its ability to differentiate its
mature products from those of its competitors. Worldwide, there are many firms
producing spinal implant devices, and certain of the Company's competitors
currently manufacture and sell interbody fusion cages that have received a
pre-market approval from the FDA. A number of these firms have greater
financial, research and development, manufacturing and sales and marketing
resources than the Company. The Company's inability to compete effectively
against existing or future competitors would have a material adverse effect on
its business, financial condition and results of operations.
Dependence On Key Personnel. The Company's future success depends in significant
part upon the continued service of certain key scientific, technical and
managerial personnel and its continuing ability to attract and retain highly
qualified scientific, technical and managerial personnel. Competition for such
personnel is intense, and there can be no assurance that the Company can retain
its current personnel or that it can attract, assimilate or retain other highly
qualified scientific, technical and managerial personnel in the future. The
Company has taken steps to retain its key employees, including the granting of
stock options that vest over time. The loss of key personnel, especially if
without advanced notice, or the inability to hire or retain qualified personnel
could have a material adverse effect upon the Company's business, financial
condition and results of operations.
Risks Associated With International Sales. A significant portion of the
Company's revenues relate to international sales of its products, which are
subject to numerous risks. Regulatory requirements, as well as pricing,
marketing and distribution structures, vary significantly from country to
country. Additionally, international sales can be adversely affected by
limitations or disruptions caused by the imposition of government controls,
export licenses, political instability, trade restrictions, changes in foreign
tax laws or tariffs, or other trade regulations and difficulties coordinating
communications among and managing international operations. Moreover, the
Company's business, financial condition and results of operations may be
adversely effected by fluctuations in overseas economic conditions and
international currency exchange rates, as well as by increases in duty rates,
difficulty in obtaining export licenses, constraints on its ability to maintain
or increase prices and competition. There can be no assurance that the Company
will be able to successfully commercialize its existing products or any of its
future products in any international market, which could have a material adverse
effect on the Company's business, financial condition and results of operations.
Dependence On Patents And Proprietary Technology. The patent and trade secret
positions of medical device companies, including those of the Company, are
uncertain and involve complex
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<PAGE> 25
and evolving legal and factual questions. The coverage sought in a patent
application either can be denied or significantly reduced before or after the
patent is issued. Consequently, there can be no assurance that any patents from
pending applications or from any future patent application will be issued, that
the scope of the patent protection will exclude competitors or provide
competitive advantages to the Company, that any of the Company's patents will be
held valid if subsequently challenged or that others will not claim rights in or
ownership of the patents and other proprietary rights held by the Company. Since
patent applications are secret until patents are issued in the United States, or
corresponding applications are published in other countries, and since
publication of discoveries in the scientific or patent literature lags behind
actual discoveries, the Company cannot be certain that it was the first to file
patent applications for its inventions. In addition, there can be no assurance
that competitors, many of which have substantial resources, will not seek to
apply for and obtain patents that will prevent, limit or interfere with the
Company's ability to make, use or sell its products either in the United States
or in international markets. Further, the laws of certain foreign countries do
not protect the Company's intellectual property rights to the same extent as do
the laws of the United States. Litigation or regulatory proceedings, which could
result in substantial cost and uncertainty to the Company, may also be necessary
to enforce patent or other intellectual property rights of the Company or to
determine the scope and validity of other parties' proprietary rights. There can
be no assurance that the Company will have the financial resources to defend its
patents from infringement or claims of invalidity.
The Company also relies upon unpatented proprietary technology, and no assurance
can be given that others will not independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to or disclose
the Company's proprietary technology or that the Company can meaningfully
protect its rights in such unpatented proprietary technology. The Company's
policy is to require each of its key employees, consultants, investigators and
advisors to execute a confidentiality agreement upon the commencement of an
employment or consulting relationship with the Company. There can be no
assurance, however, that these agreements will provide meaningful protection for
the Company's proprietary information in the event of unauthorized use or
disclosure of such information.
Dependence On Suppliers. The Cortical Bone Dowel, a product the Company markets
on behalf of Regeneration Technologies, Inc. ("RTI"), an affiliate of the
University of Florida Tissue Bank, is made of human bone tissue obtained from
cadavers. RTI supplies significant amounts of such tissue pursuant to an
exclusive agreement with the Company. There can be no assurance that the supply
of bone tissue will continue to meet current demand, or that the Company, if
required, will be able to locate alternative sources of human bone tissue on a
timely and cost-effective basis. To date, constrained supply of human bone
tissue has limited growth in this area. There can be no assurance that the RTI
will meet the Company's future delivery requirements of human bone tissue. The
inability to procure an adequate supply of such tissue could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Year 2000. The "Year 2000" issue is the result of computers being designed to
use two digits rather than four to define the applicable year. Any computer
hardware or software, or other systems which are operated using embedded
computer chips, may contain time-sensitive
25
<PAGE> 26
programs that recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices or engage in similar normal business
activities.
Sofamor Danek Group, Inc. and its subsidiaries are assessing their readiness for
the arrival of the Year 2000, and the related risks of business interruption as
a result of the Year 2000 issue. This assessment includes a review of the
Company's computer hardware, computer software, and other electronic systems
which use embedded chips to operate. The Company believes that it is reviewing
all of its systems and equipment which could materially impact operations if not
Year 2000 compliant. In some cases, this assessment includes representations
from the makers of hardware and software that their products are Year 2000
compliant. Based on its analysis to date, as well as representations from
others, the Company believes that steps it is taking will result in its
computer-based systems being fully capable of operating upon the arrival of the
year 2000.
At this point, the Company believes that all of its computer hardware is Year
2000 compliant, and that the majority of its current software is Year 2000
compliant. Several subsidiaries within the Company's international division use
software packages that are not currently Year 2000 compliant. The Company
expects to bring these subsidiaries into compliance through the worldwide
installation of a comprehensive software package, which will contain integrated
general ledger, customer and sales, inventory, accounts payable, human resource
and other information. This software is Year 2000 compliant and will be
installed at operating locations beginning in first quarter 1999, with
installation priority given to those subsidiaries which are not currently Year
2000 compliant. Although the installation of this software will result in
worldwide Year 2000 compliance, this project is being done in the ordinary
course of business and not as a solution for the Year 2000 issue, as the
installation also offers various enhancements to productivity and customer
service. The cost of purchasing and installing this software is expected to be
approximately $8.0 million, and the majority of these costs will be capitalized.
Should the installation of this software be delayed, the Company feels that it
has in place adequate contingency plans to accommodate the arrival of the Year
2000. Where possible, international subsidiaries are being upgraded to Year 2000
compliant versions of their current software. In cases where this is not
possible, the Company would implement short-term solutions using alternative
software applications that are Year 2000 compliant.
In an effort to determine the third-party impact on the Company, the Company is
also in the process of surveying its key vendors and customers regarding their
own Year 2000 readiness. This survey process is expected to be complete by the
end of the year. The Company has no customers that are individually material to
its reported revenues. Additionally, the Company does not anticipate that
noncompliance by its customers would preclude it from transacting sales with
them. The majority of the Company's vendors are not critical to its business
and, in the event of their noncompliance, the Company could easily locate
alternative products from compliant vendors. The Company is focusing its vendor
survey efforts on suppliers of raw materials that are an integral part of its
manufacturing process. In management's opinion, the inability to procure these
items would have the greatest impact on the Company's operations.
26
<PAGE> 27
Though the third-party survey process is not yet complete, the Company expects
no business interruptions and no material impact on its business due to
noncompliance by third parties with whom it has relationships.
A subsidiary of the Company, Surgical Navigation Technologies, Inc. (SNT),
produces and sells image guided surgical navigation systems that are used in
cranial and spinal surgery. All SNT products are Year 2000 compliant and have
been since the products' inception.
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved from time to time in litigation on various matters which
include intellectual property, commercial affairs and product liability. Given
the nature of the Company's business activities, these lawsuits are considered
routine to the conduct of its business. The result of any particular lawsuit
cannot, because, among other things, of the very nature of litigation, the
litigation process and its adversarial nature, and the jury system, be
predicted.
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 FDA rules and regulations (governing
marketing and labeling of medical devices), that pedicle fixation has not been
proven safe and effective in the context of FDA labeling standards, that some or
all of the spinal systems are defectively designed and manufactured and that
plaintiffs have suffered a variety of injuries as a result of their physicians'
use of such systems in pedicle fixation. The Company has also been named as a
defendant in a number of lawsuits instituted by plaintiffs who have received
spinal implants manufactured by other manufacturers and in which the Company is
alleged to have participated in a conspiracy among doctors, manufacturers,
hospitals, teaching institutions, professional societies and others to promote,
in violation of applicable law, the use of spinal implants.
In a number of cases, plaintiffs have sought to proceed as representatives of
classes of spinal implant recipients. All efforts to obtain class certification
have been denied or withdrawn, except with respect to a class-action settlement
entered into between the plaintiffs and another spinal implant manufacturer,
AcroMed Corporation ("Acromed") (see below under the heading entitled "AcroMed
Corporation Settlement"). Some plaintiffs have filed individual lawsuits,
whereas other lawsuits list multiple plaintiffs and, in certain instances,
multiple lawsuits have been filed on behalf of the same individual plaintiffs.
Plaintiffs typically seek relief in the form of monetary damages, often in
unspecified amounts. Many of the plaintiffs only allege as monetary
27
<PAGE> 28
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.
Since the litigation began, over 1,000 plaintiffs have been dismissed. As of
September 30, 1998, the claims of approximately 2,100 plaintiffs who received a
product made by the Company remain active in litigation against the Company. The
majority of these plaintiffs filed their claims in 1995. Of these, approximately
800 are in federal courts, and approximately 1,300 are in state courts. The
Company is also named as a defendant in lawsuits involving about 1,950
plaintiffs (230 federal, 1,720 state) where the Company is alleged to have
conspired with competitors and others, in violation of applicable law, to
promote the use of spinal implant systems.
The Company believes that it has meritorious defenses to these claims,
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. As of September 30, 1998,
the Company has been awarded summary judgment in 42 cases and partial summary
judgment in three cases. It has been denied summary judgment in three cases, and
has 83 motions for summary judgment pending. The Company believes that all
product liability lawsuits currently pending against it are without merit and it
will continue to defend against them vigorously.
FEDERAL MULTIDISTRICT LITIGATION (MDL 1014)
On August 4, 1994, the Federal Judicial Panel on Multidistrict Litigation
ordered all federal court lawsuits to be transferred to and consolidated for
pretrial proceedings, including the determination of class certification, in the
United States District Court for the 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 ("Judge 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. On April 16, 1997, Judge Bechtle dismissed
all conspiracy claims alleging fraud on the FDA. On August 13, 1998, 870
conspiracy claims pending in the Multidistrict Litigation were dismissed. (The
dismissal of these conspiracy claims is on appeal.) As of September 30, 1998,
the Company remains a defendant in approximately 550 individual claims and 130
conspiracy claims still consolidated in the Multidistrict Litigation.
28
<PAGE> 29
FEDERAL REMANDED CASES
Discovery has been completed in most of the federal court cases and is
continuing in those that remain. Judge Bechtle has initiated the process of
transferring or remanding the federal court cases to various federal courts
throughout the United States. As of September 30, 1998, the Federal Judicial
Panel on Multidistrict Litigation has ordered the remand of more than 300 cases
to transferor courts for further proceedings. Cases involving more than 90
plaintiffs are currently pending remand. It is expected that the 550 remaining
individual cases against the Company in the Multidistrict Litigation will be
remanded over the next several months. The first federal court cases have been
scheduled for trial in 1998, although these dates often change.
STATE COURT LITIGATION
As of September 30, 1998, there were approximately 1,300 individual claims
pending against the Company in several state courts around the country,
principally in Tennessee, Oklahoma, Texas and Pennsylvania. In additional, there
were approximately 1,700 conspiracy claims pending in state courts. Of these
individual claims, the lawsuits of approximately 1,100 plaintiffs are pending in
Memphis, Tennessee. The presiding state court judge in Memphis established a
case management plan, which selected eight representative cases for preparation
and trial. Summary judgment in favor of the Company has been granted in seven of
the eight representative cases. Those summary judgment decisions are on appeal.
A motion for summary judgment is pending in the remaining representative case in
Memphis against the Company.
Discovery is proceeding in all remaining state court cases. A number of other
state court cases around the country have been scheduled for trial in 1998,
although delays in trial dates are common. In May, 1998, a jury in Houston,
Texas rendered a verdict adverse to the Company in the amount of $0.4 million.
The Company does not believe that that verdict was justified by the evidence and
has appealed.
ACROMED CORPORATION SETTLEMENT
In December 1996, AcroMed, a spinal implant manufacturer and a defendant in many
of the cases pending in the Multidistrict Litigation, and the Plaintiffs' Legal
Committee in the Multidistrict Litigation announced that they had entered into a
conditional settlement regarding all product liability claims involving the use
of AcroMed devices to achieve pedicular fixation with screws in spinal fusion
surgery. Under the terms of the settlement, AcroMed has established a settlement
fund consisting of $100.0 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 appeals of Judge
Bechtle's certification and approval order have been withdrawn.
29
<PAGE> 30
INSURANCE
Several insurance carriers have asserted reservation of rights concerning the
scope and timing of the Company's insurance coverage available in connection
with product liability litigation, but have not denied insurance coverage to the
Company. Three of the carriers, Royal Surplus Lines Insurance Company ("Royal"),
Steadfast Insurance Company ("Steadfast") and Agricultural Excess and Surplus
Insurance Company ("Agricultural"), have each filed declaratory judgment actions
against the Company seeking clarification of their rights and obligations, if
any, under their respective policies. Neither Royal nor Agricultural has paid
amounts due to the Company. Steadfast has paid only a portion of the amounts due
to the Company.
The Royal, Steadfast and Agricultural lawsuits are pending in the United States
District Court for the Western District of Tennessee in Memphis. The Company
believes that its 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. In the Royal litigation a motion seeking
the interim payment of the Company's defense costs was denied, but the court has
scheduled a further hearing to determine whether the motion may be granted with
respect to specific claims asserted against the Company. The Company has filed
answers and counterclaims in the Steadfast litigation and intends to file
answers and counterclaims in the Agricultural litigation. The Company believes
that Royal's, Steadfast's and Agricultural's claims are without merit and will
defend against them vigorously.
As is common in the insurance industry, the Company's insurance policies
covering product liability claims must be renewed annually. The Company has in
force insurance coverage for product liability claims including orthopedic bone
screw claims, subject to the terms, conditions and limits of the individual
insurance policies. Except for a policy issued by Royal, the Company's insurance
policies are reduced by the costs of defense. In some instances, the cost of
defending these claims has been reimbursed by certain of the primary and excess
insurance carriers. Although the Company has been able to obtain insurance
relating to product liability claims at a cost and on other terms and conditions
that are acceptable to the Company, there can be no assurance that in the future
it will be able to do so.
On January 6, 1997, the Company announced that its 1996 financial results would
include a pre-tax charge of $50.0 million relating to costs associated with the
product liability litigation described above. The charge, which was reflected in
the Company's 1996 financial statements, covers the reasonable foreseeable costs
that the Company was positioned in late December 1996 to estimate because the
litigation had progressed and because changes in the fourth quarter of 1996 had
occurred in facts and circumstances relating to the litigation. Among the
changed facts and circumstances were the announcement of the AcroMed settlement
described above, the likelihood that the litigation will continue for several
years, in part, due to the additional financial resources provided to the
plaintiffs' attorneys as a result of the AcroMed settlement, the absence of
AcroMed as a member of the joint defense group, the status of the Company's
insurance described above and the continuing absence of dispositive rulings
relating to the Company's defense motions.
30
<PAGE> 31
While it is not possible to accurately predict the outcome of litigation, the
amount of the accrual, which remained on the Company's consolidated balance
sheet at September 30, 1998, represents the Company's best judgment of the
probable reasonable costs (in excess of the amount of insurance the Company
believes is recoverable) to defend and conclude the lawsuits based on the facts
and circumstances currently existing. The costs provided for in the accrued
liability include, but are not limited to, legal fees paid or anticipated to be
paid and other costs related to the Company's defense and conclusion of these
matters.
The actual costs to the Company could differ from the estimated charge and will
be dependent upon a number of factors that will not be known for some time,
including, among other things, the resolution of defense motions and the extent
of further discovery. Although an adverse resolution of lawsuits could have a
material effect on the Company's results of operations and cash flows in future
periods, the Company does not believe that these matters will in the future have
a material adverse effect on its consolidated financial position. The Company is
unable to predict the ultimate outcome or the financial impact of the product
liability litigation.
SECURITIES LAWS ACTIONS
Beginning in April 1994, the Company and four of its officers and directors were
named in five shareholder lawsuits filed in the United States District Court in
Memphis, Tennessee. Four of the lawsuits purported to be class actions. All of
the lawsuits were consolidated into one case in the United States District Court
in Memphis through an amended complaint which added four new individual
defendants who are either current or former directors of the Company. The
lawsuit alleged that the defendants made false and misleading statements and
failed to disclose material facts to the investing public and sought money
damages. The alleged securities law violations were 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 U.S. distributor of Sofamor products, National Medical
Specialties, Inc. 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. On August 14, 1997, the Court of Appeals for the
Sixth Circuit affirmed the dismissal of the plaintiffs' complaint. On May 4,
31
<PAGE> 32
1998 the United States Supreme Court declined to review the plaintiffs' case.
The dismissal of the plaintiffs' case is now final.
INTERNAL REVENUE SERVICE DOCUMENT PRODUCTION
On April 29, 1998, the Internal Revenue Service (the "IRS") served the Company
with a summons covering the 1993, 1994 and 1995 taxable years. Generally, the
IRS is requiring the production of (i) documents supporting expenses incurred in
connection with trips attended by physicians, (ii) documents relating to
payments made to physicians for consulting, (iii) documents relating to stock
options granted, royalty agreements and payments, fellowship grants/awards,
scholarships and honorariums, (iv) a list of Company customers, (v) certain
revenue information and (vi) a report with respect to governmental customers.
The Company is cooperating fully with the IRS in this matter.
See 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 Dependence on Patents and
Proprietary Technology."
Item 5. OTHER INFORMATION
PATENT LITIGATION
A patent infringement lawsuit commenced in 1993 by AcroMed Corporation, a
competitor of the Company, has been set for trial in the United States District
Court in Cleveland, Ohio in late April, 1999. AcroMed claims that certain of the
Company's plate and rod implant systems infringe four of its patents and is
seeking damages and injunctive relief. The Company has obtained summary judgment
regarding two of the patents in the lawsuit, and the Court is presently
considering arguments as to claim interpretation with respect to the remaining
two patents, one of which relates to a bone plate and the other to a bone bolt.
The Company continues to vigorously defend against the remaining claims,
believes that it does not infringe any of the patents in the lawsuit and
believes that it has valid defenses to the claims of infringement. There can be
no assurances as to the outcome of this lawsuit, however, and an adverse outcome
could be material to the Company.
SHAREHOLDER PROPOSALS
If any shareholder intends to present a proposal for consideration at the 1999
Annual Meeting of Shareholders, such proposal must be received by the Company
not later than December 1, 1998 to be eligible for inclusion in the Company's
proxy statement and form of proxy for such meeting. Any proxy received by the
Company in connection with the 1999 Annual Meeting of Shareholders may confer
discretionary authority to vote on any shareholder proposal not received by the
Company not earlier than February 19, 1999 or later than March 22, 1999, but if
the first public announcement of the date of the 1999 Annual Meeting of
Shareholders is later than March 22, 1999, then on the seventh day following
that first public announcement. If the date of the 1999 Annual Meeting of
Shareholders of the Company is changed by more than 30 days from the date of the
1998 Annual Meeting of Shareholders, then this change will be disclosed in the
earliest possible Form 10-Q of the Company and any shareholder proposal to be
presented at the 1999 Annual Meeting of Shareholders must be received by a
reasonable time before the Company mails its proxy materials for the 1999 Annual
Meeting of Shareholders.
32
<PAGE> 33
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
a) Exhibit No. Description
----------- -----------
<S> <C>
10.1 Agreement and Plan of Merger, dated November 1, 1998,
by and among Medtronic, Inc., MSD Merger Corp. and
Sofamor Danek Group, Inc. (incorporated by reference
to Exhibit 2.1 to the Company's Current Report on
Form 8-K filed on November 9, 1998).
10.2 Stock Option Agreement, dated November 1, 1998, by
and between Medtronic, Inc. and Sofamor Danek Group,
Inc. (incorporated by reference to Exhibit 2.2 to
the Company's Current Report on Form 8-K filed on
November 9, 1998).
27.1 Financial Data Schedule
(For SEC use only)
27.2 Amended September 30, 1997 Financial Data Schedule
(For SEC use only)
b) Reports on Form 8-K
A report on Form 8-K was filed on November 9, 1998, which included
an Agreement and Plan of Merger and a Stock Option Agreement related
to the proposed merger between the Company and Medtronic, Inc.
</TABLE>
33
<PAGE> 34
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 10, 1998 BY: /s/ E.R. Pickard
--------------------- ---------------------------------
E.R. Pickard
Chairman, Chief Executive Officer
and Director
(Principal Executive Officer)
DATE: November 10, 1998 BY: /s/ George G. Griffin, III
--------------------- --------------------------------
George G. Griffin, III
Executive Vice President
and Chief Financial Officer
(Principal Financial Officer)
34
<PAGE> 35
SOFAMOR DANEK GROUP, INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Number Description of Exhibit
-------------- ----------------------
<S> <C>
10.1 Agreement and Plan of Merger, dated November 1, 1998,
by and among Medtronic, Inc., MSD Merger Corp. and
Sofamor Danek Group, Inc. (incorporated by reference
to Exhibit 2.1 to the Company's Current Report on
Form 8-K filed on November 9, 1998).
10.2 Stock Option Agreement, dated November 1, 1998, by
and between Medtronic, Inc. and Sofamor Danek Group,
Inc. (incorporated by reference to Exhibit 2.2 to
the Company's Current Report on Form 8-K filed on
November 9, 1998).
27.1 Financial Data Schedule
(For SEC use only)
27.2 Amended September 30, 1997 Financial Data Schedule
(For SEC use only)
</TABLE>
35
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 70,132
<SECURITIES> 9,535
<RECEIVABLES> 110,422
<ALLOWANCES> 2,395
<INVENTORY> 75,409
<CURRENT-ASSETS> 331,070
<PP&E> 58,304
<DEPRECIATION> 28,372
<TOTAL-ASSETS> 542,382
<CURRENT-LIABILITIES> 115,867
<BONDS> 18,067
0
0
<COMMON> 381,167
<OTHER-SE> (18,830)
<TOTAL-LIABILITY-AND-EQUITY> 542,382
<SALES> 283,683
<TOTAL-REVENUES> 283,683
<CGS> 51,631
<TOTAL-COSTS> 51,631
<OTHER-EXPENSES> 57,643
<LOSS-PROVISION> 562
<INTEREST-EXPENSE> 2,989
<INCOME-PRETAX> 43,330
<INCOME-TAX> 11,553
<INCOME-CONTINUING> 29,223
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 29,223
<EPS-PRIMARY> 1.11
<EPS-DILUTED> 1.02
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 5,553
<SECURITIES> 70
<RECEIVABLES> 78,782
<ALLOWANCES> 1,693
<INVENTORY> 67,839
<CURRENT-ASSETS> 194,562
<PP&E> 47,051
<DEPRECIATION> 22,824
<TOTAL-ASSETS> 374,529
<CURRENT-LIABILITIES> 65,873
<BONDS> 70,239
0
0
<COMMON> 68,392
<OTHER-SE> 123,202
<TOTAL-LIABILITY-AND-EQUITY> 374,529
<SALES> 221,378
<TOTAL-REVENUES> 221,378
<CGS> 39,661
<TOTAL-COSTS> 39,661
<OTHER-EXPENSES> 14,319
<LOSS-PROVISION> 393
<INTEREST-EXPENSE> 4,221
<INCOME-PRETAX> 60,757
<INCOME-TAX> 17,496
<INCOME-CONTINUING> 40,831
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 40,831
<EPS-PRIMARY> 1.65
<EPS-DILUTED> 1.54
</TABLE>
