UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
X EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from to
Commission file number 33-69286
WRIGHT MEDICAL TECHNOLOGY, INC.
(Exact name of registrant as specified in its charter)
Delaware 62-1532765
(State or other jurisdiction (I.R.S. employer
of incorporation or organization) identification no.)
5677 Airline Road, Arlington, Tennessee 38002
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (901) 867-9971
Securities registered pursuant to Section 12(b) of the Securities Exchange Act
of 1934: None
Securities registered pursuant to Section 12(g) of the Securities Exchange Act
of 1934: None
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. Yes X No
The registrant has no publicly traded equity securities, no market
quotations are available and accordingly, information is not provided with
respect to the aggregate market value of voting stock held by non-affiliates of
the registrant.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of March 13, 1998 the registrant had 9,721,075 shares outstanding of
Class A Common Stock, $0.001 par value per share.
DOCUMENTS INCORPORATED BY REFERENCE. None
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TABLE OF CONTENTS
PART I
Item 1. Business
Overview.........................................................3
Principal Products...............................................5
Marketing and Distribution......................................15
Competition.....................................................16
Manufacturing and Quality Control...............................17
Government Regulations..........................................18
Research and Product Development................................19
Principal Customers.............................................20
Raw Materials...................................................20
Environmental...................................................21
Insurance.......................................................21
Patents and Trademarks..........................................22
Royalty and Other Payments......................................22
Seasonality.....................................................22
Employees.......................................................23
Item 2. Properties........................................................23
Item 3. Legal Proceedings.................................................24
Item 4. Submission of Matters to a Vote of
Security Holders..................................................25
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters...............................................26
Item 6. Selected Financial Data...........................................27
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations...............................28
Item 8. Financial Statements and Supplementary Data.......................36
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...............................36
PART III
Item 10. Directors and Executive Officers of the Registrant................37
Item 11. Executive Compensation............................................41
Item 12. Security Ownership of Certain Beneficial Owners
and Management ...................................................47
Item 13. Certain Relationships and Related Transactions....................50
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K...............................................54
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PART I.
ITEM 1. BUSINESS.
Overview
Wright Medical Technology, Inc., a Delaware corporation (collectively with
its subsidiaries, the "Company") is a designer, manufacturer and worldwide
distributor of orthopaedic implant devices and instrumentation for
reconstruction and fixation. Dedicated to bringing solutions to the orthopaedic
industry, Wright Medical Technology, Inc. provides innovative products and
services that address the critical issues in the changing orthopaedic healthcare
arena. Reconstructive devices are for joint arthroplasty that involve the
replacement with mechanical substitutes of impaired skeletal joints such as
knees, hips, shoulders, and the small joints of the extremities (elbow, hands
and feet). The Company also currently offers devices for 1) fracture fixation
due to trauma, 2) arthroscopic surgery of the knee, shoulder and extremities,
and 3) the spine to aid in correction of deformity and instability.
In addition, the Company is developing a wide range of new biological
products that are designed to solve orthopaedic problems by, in some cases,
delaying or obviating the need for traditional orthopaedic solutions.
OSTEOSET(R) Bone Graft Substitute is a patented bio-orthopaedic product that,
compared to current bone graft alternatives, is ideal for bone grafting
procedures because it is both biocompatible and bioresorbable. It can also be
used in the presence of infection. The Company received FDA clearance for
OSTEOSET(R) Bone Graft Substitute in June 1996 and introduced the product in
August 1996 for the treatment of bony voids and gaps of the extremities. On May
9, 1997, the Company announced that the U.S. Food and Drug Administration
cleared OSTEOSET(R) Bone Graft Substitute for use in the spine and pelvis.
Currently OSTEOSET(R) is the only bone graft substitute cleared for these
indications.
Also, the Company is engaged in a joint venture agreement with Tissue
Engineering, Inc. ("TEI") a Boston, Massachusetts company that develops and owns
technology to produce collagen-based scaffolds which can be used for durameter
replacement, ligament and tendon reconstruction, for cartilage regeneration, and
for use with calcium phosphate/sulfate as a bone graft substitute. The joint
venture will further develop and commercialize those products for use in the
treatment of musculoskeletal problems based on TEI technology.
The Company's business strategy is to design and develop unique and
innovative products to solve clinical orthopaedic problems. In
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order to better achieve that goal, in early 1998 the Company determined to
narrow its product focus and to concentrate its resources and working capital on
products in its hip, knee and extremity product lines and to expand its already
strong portfolio of biologic products. The Company plans to expand its product
and technology base in these areas through investment in internal research and
development and through the acquisition of new products and technologies. As a
result, the Company will seek to divest its assets related to its spinal, trauma
and arthroscopy products.
The Company's headquarters, manufacturing and distribution facilities are
located in Arlington, Tennessee. Products are distributed throughout the world
through a combination of distributors and wholly owned subsidiaries. Principal
markets include the United States, Canada, Japan, France, Spain, Australia, and
Taiwan.
In July 1993, the Company was founded to acquire substantially all the
assets of the large joint orthopaedic implant business of Dow Corning Wright
Corporation, a subsidiary of Dow Corning Corporation (collectively "DCW")(the
"Acquisition"). Unless the context otherwise requires, the term "Company" as
used herein refers to Wright Medical Technology, Inc. and its subsidiaries.
Throughout this document, products are discussed that are currently under
development or, for which clearance by the FDA (or applicable foreign regulatory
clearance) has not been received. The Company can give no assurance that any of
these products will in fact be successfully developed, that the necessary FDA or
foreign approvals will be received or that, if developed and approved, a market
for these products will exist.
This document includes forecasts and projections that are forward looking
statements based on management's current expectations of the Company's near term
results, based on currently available information pertaining to the Company.
Actual future results and trends may differ materially depending on a variety of
factors, including competition in the marketplace, changing market conditions,
demographic trends, product research and development, government approvals,
government reimbursement schedules and other factors. Results of operations in
the industry generally show a seasonal pattern, as customers reduce shipments
during the warm weather months. The Company assumes no obligation for updating
any such forward looking statements.
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Principal Products
The Company's revenues are derived primarily from the sale of orthopaedic
implant devices for reconstruction and fixation. The United States population
over 60 years of age continues to grow as a percentage of the total population.
The aging of the population is significant in that approximately 70% of all
joint implants are for patients over 60 years of age. Osteoarthritis
(degenerative joint disease) affects over 15 million people in the United States
and is the primary indication for orthopaedic implants. Management believes that
as the population ages, the incidence of osteoarthritis and other ailments will
increase and, as a consequence, the demand for orthopaedic implants and new
solutions for medical problems requiring orthopaedic applications should rise.
Management believes that another factor affecting growth of implant use is the
increasingly active lifestyle of many older Americans. A more active lifestyle
not only accelerates the joint degeneration process, but also increases the
expectations that people have of their bodies. Joint degeneration leads to pain
and decreased mobility, while active lifestyles also may result in more
sports-related traumatic injuries necessitating total joint procedures later in
life. As a result, the Company believes that the need for new and innovative
orthopaedic solutions will continue to grow.
Reconstructive Knee Products
The Company currently markets several reconstructive knee systems including
the AXIOM(R) Total Knee System (the "AXIOM(R) Knee"), the ADVANTIM(R) Total Knee
System (the "ADVANTIM(R) Knee"), and the ADVANCE(R) Total Knee System (the
"ADVANCE(R) Knee"). Each of these systems is designed to duplicate the
anatomical function of the patient's knee, thereby improving its range of motion
and stability. In a typical knee replacement, the surgeon may replace the
articulating surfaces of the knee: the knee cap (patella), top of the shin bone
(tibia) and bottom of the thigh bone (femur). In the majority of total knee
replacement surgeries, the surgeon can choose to leave the posterior cruciate
ligament ("PCL") intact (necessitating a PCL sparing knee component) or remove
that ligament (necessitating a posterior stabilized knee component).
The ADVANCE(R) Posterior Stabilized Knee represents a new standard for
primary posterior stabilized total knee arthroplasty developed by the Company in
conjunction with the surgeons and engineers of Hospital for Special Surgery
("HSS"). With over 20 years experience in designing total knee replacements, the
HSS team worked with the Company to create a product with many key design
advantages. It provides enhanced patellofemoral tracking, improved resistance to
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subluxation and increased tibiofemoral contact area. Increased range of motion
is achieved through the improved overall kinematics of the ADVANCE(R) knee.
In 1997, the Company continued to expand the indications of the ADVANCE(R)
Knee System by developing the Posterior Cruciate Ligament sparing components and
a very unique medial-pivot articulation product which will be available in
limited release in early 1998. The patented medial-pivot articular surface is
designed to decrease surface wear and reproduce normal knee function. Five
styles of instrumentation provide an easy transition from other systems. The
Company believes that the ADVANCE(R) Knee is one of the most advanced knee
systems on the market and will play a critical role in its future growth. Full
commercial launch of the PCL sparing and medial pivot products is expected later
this year.
All polyethylene components are manufactured from the Company's proprietary
DURAMER(R) polyethylene. Since its formation, the Company has been committed to
polyethylene research and development. As a result, the Company developed
DURAMER(R) EtO Sterilized polyethylene which eliminates the incidence of
gamma-induced oxidation and associated poly wear in the joint.
The Company's leading knee product continues to be the ADVANTIM(R) Knee,
designed to address the needs of the high demand patient. The ADVANTIM(R) Total
Knee System was first introduced in 1982. The durability of the system is
enhanced through optimized femorotibial contact areas and reduced roughness of
all articulating surfaces. Developed to meet the needs of patients with special
stability requirements, the ADVANTIM(R) Posterior Stabilized implants
incorporate a unique combination of design features including precise
restoration of the patellar tracking mechanism, wide femoral condyles, cast
femoral housing, optimal tibial fixation, and modular femoral and tibial stems.
The ADVANTIM(R) Total Knee System also offers a variety of tibial implant
choices, utilizes simple and precise instrumentation with a single reference
point to ensure accurate bone cuts, and allows the advantages of patient demand
matching with one set of instruments.
With the addition of the ADVANCE(R) Knee and AXIOM(R) Knee, the Company is
well positioned to achieve growth in its total knee arthroplasty business.
Reconstructive Hip Products
The Company currently markets a wide choice of hip products including those
with brand names of PERFECTA(R), EXTEND(TM), INFINITY(R), NEXUS(R), BRIDGE(R),
CONSERVE(R), S.O.S.(R), INTERSEAL(R), and TRANSCEND(R).
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These systems are designed to replace all or a portion of the natural hip joint.
The Company's hip implants consist of the same basic parts as the natural hip,
including a femoral stem inserted into the femur (thigh bone) with a spherical
femoral head (ball) and an acetabular cup (socket) on which the femoral head
articulates. The Company's hip systems include several different femoral stem
and acetabular cup designs. Each product is designed to address a specific
segment of the total hip market. Surgeons have the option of interchanging stem,
head and acetabular cup designs to meet their own preferences and individual
patient requirements. The femoral stems currently marketed by the Company are
made of a titanium or cobalt chrome alloy. Acetabular cups are comprised of
ultra high molecular weight polyethylene available with or without a metal
backed shell with different surfaces to enhance fixation to the pelvis.
The INTERSEAL(R) Acetabular Cup is a system of titanium porous- coated
metal shells and modular liners providing the surgeon with extensive
intraoperative flexibility. This product was introduced in 1995 and remains the
Company's primary acetabular component. The modified hemispherical design
provides rigid fixation at the rim with a secure lock at the shell/liner
interface. An apical hole in the shell allows the surgeon to confirm that the
shell is bottomed out in the pelvis, and a plug seals the hole from the invasion
of particulate. The system also features a quadrant style shell featuring
optional screw fixation and lateralized liners for revision cases, and a
multiple hole cup for difficult revision cases and liners with additional
inner-diameter choices. The Company believes that the superior characteristics
of the INTERSEAL(R) System will also benefit the sales of its existing and newly
released hip stems.
The S.O.S.(R), or Segmented Orthopaedic System, was created to offer limb
salvage to the patient who suffers bone loss due to cancer, trauma or failed
implants. The present system consists of the Proximal Femur System and the
Distal Femur System. The Company is in the process of reviewing its options to
expand this system.
In 1997, the Company after years of research, commercialized the
TRANSCEND(R) metal-on-metal and ceramic-on-ceramic articulating surface systems.
The Company has commenced clinical studies in the United States and markets the
products in Australia and Canada where they have been favorably received. The
Company believes that these systems, which eliminate the use of a polyethylene
bearing surface in the hip, will provide advantages over conventional hip
systems by reducing long term wear debris.
The CONSERVE(R) System provides a solution for patients who have avascular
necrosis of the femoral head. This disease cuts off the
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blood supply to the femoral head, killing the bone and causing pain for the
patient. People who suffer from avascular necrosis are usually younger than the
typical hip replacement patient and therefore need a solution less aggressive
than a total hip replacement. With the CONSERVE(R) Femoral Resurfacing System,
only the femoral head is resurfaced and the rest of the hip remains untouched.
This allows the patient to live without pain and avoid extensive hip surgery at
a young age.
The PERFECTA(R) RS Hip Stem is the most recent addition into the
PERFECTA(R) Total Hip System family of implants. The PERFECTA(R) RS utilizes the
proven proximal tri-planer wedge geometry, as well as medial flare options of
standard and reduced flare for optimal fit in various bone geometries. Proximal
plasma spray coatings compliment this geometry for stable interface fixation.
The distal portion of the stem is cylindrical in nature and is highly polished
with a coronal slot. A series of raised splines coincide with precise
instrumentation to provide intimate implant bone fit for initial and long term
stability.
The Company's femoral stems are offered generally in smooth, porous-coated
and textured surfaces including hydroxylapalite allowing for bone on-growth,
bone in-growth, press-fit or cemented applications.
The Company also offers ORTHOSET(R) radiopaque Bone Cement. Two types of
ORTHOSET(R) Bone Cement are available. ORTHOSET(R) HV is high viscosity in
nature and ORTHOSET(R) LV is low viscosity in nature. Both versions are
radiopaque, have minimal monomer release, and incorporate excellent exothermic
and strength characteristics.
These product lines should place the Company in a position to sustain
continued growth in primary and revision hip surgery, as well as limb salvage
cases. The products allow the orthopaedic surgeon a wide range of material and
design choices to solve the varied medical problems of individual patients.
Extremity Products
The Company's extremity products, and particularly its small joint
orthopaedic implants, have a long clinical history and over one million devices
have been implanted during their 25-year history. Many of the Company's small
joint orthopaedic implants were developed initially and patented by
surgeon-inventor Dr. Alfred Swanson. The Company has the exclusive rights to use
the surgeon's name and patents.
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Most of the small joint orthopaedic implants being distributed by the
Company are manufactured using solid silicone elastomers (known for their
fatigue strength, tear-resistance and biocompatibility), and titanium that is
used to manufacture protective sleeves (grommets) for some of these implants.
The balance of such small joint orthopaedic implants are manufactured primarily
from titanium and are commonly used in more active patients. Key extremity
products include:
Hand Implants. Flexible one-piece hand implants are designed to help
restore function to damaged or diseased small joints within the hand.
Key hand implants include the Swanson Flexible Hinge Finger Joint with
grommets, the Swanson Titanium Basal Thumb Implant and the Swanson
Trapezium Implant.
Wrist Implants. Wrist implants are designed to restore the anatomical
relationship of the joint connecting the wrist and the hand. Wrist
implants include the Swanson Wrist Joint Implant with grommets, the
Titanium Lunate Implant and the Titanium Scaphoid Implant.
Foot Implants. Foot implants are designed to replace damaged or
diseased small joints found within the foot. Principal products include
the Swanson Titanium Great Toe Implant, the Hammertoe Implant, the
Swanson Flexible Hinge Toe Implant with grommets and the Smith STA-Peg.
Elbow Implants. The Company recently introduced the Sorbie- Questor(R)
Total Elbow System. The elbow's design promotes accurate joint
tracking, proportionate distribution of load forces between the
humerus, ulna and radius and the replication of the elbow's natural
anatomic structure. The unique instrumentation enhances results. This
device was developed in cooperation with Charles Sorbie, M.D., a
well-known Canadian orthopaedic surgeon and inventor.
The Company also manufactures the Swanson Titanium Radial Head implant, an
alternative to its silicone elastomer radial head implant. The implant is
manufactured from commercially pure titanium that features nitrogen ion
implantation for increased surface hardness. The overall profile of the implant
head is unchanged from the silicone radial head implant design.
Shoulder Implants
Shoulder implants are designed to replace the articulating surfaces of the
shoulder joint damaged principally as a result of
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osteoarthritis and trauma. The Company distributes the Neer II and Modular
shoulder prostheses manufactured by the 3M Corporation.
As part of its newly focussed product strategy, the Company will seek to
expand its entire line of extremity products.
Biologic Product Opportunities
As a primary strategic focus of the business, the Company continues to
commit substantial resources and working capital to the development expansion
and commercialization of its portfolio of biologic products.
OSTEOSET(R) bone graft substitute is the Company's first entry into the
bone graft market, which market is approaching one-half billion dollars in the
U.S. annually. OSTEOSET(R) is currently offered in sterile pellet form.
Bone is the second most frequently implanted material in the human body,
being second only to blood transfusions. More than 300,000 bone graft procedures
are completed annually in the United States. Bone grafts are used to repair bone
defects caused by surgery, tumors, trauma, implant revisions, and bone
infections. Another common use of large quantities of this product is in the
fusion of the spine after instrumentation has been completed.
The preferred method of treating bone voids involves the use of autologous
graft, in which bone is taken directly from the patient. This graft usually
achieves good results, yet often requires that a second (harvesting) procedure
be performed in order to obtain enough bone to fill the defect. The iliac crest
of the pelvis is one of the most common sites that is used to harvest bone and
this requires another surgical procedure which leads to added infection risk,
morbidity, and increased recovery time.
Currently the second most common bone graft alternative is an allograft
from human bone banks. This is human bone which is frequently recovered from
deceased persons who have had their bone harvested and saved either by hospital
bone banks or by commercial corporations which provide this bone as a commercial
product. Because this is human bone it has the same typical problems that are
encountered with the use of any foreign substance within the body. This bone,
even though it is sterilized, may transmit viral diseases and create foreign
body reactions in the host. Because of the extensive processing and testing
required to provide this bone, it tends to be more costly than other forms of
bone void filler. This type of graft can also be hard to obtain at times
depending upon the
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availability of human donors or the ability of hospitals and commercial bone
banks to obtain the tissues.
The third alternative for bone grafting procedures is the use of artificial
materials. The types of artificial materials currently in use include
coral-based products, bovine collagen-based products and OSTEOSET(R). These
artificial materials are called osteoconductive substitutes since they allow
bone to grow into and upon them which can form a lattice-like structure similar
to bone for defect repair.
Compared to the two other current alternatives to human bone, OSTEOSET(R)
products provide an ideal bone void filler for many bone grafting procedures
because they are biocompatible, bioresorbable and provided in a sterile form. As
a bioresorbable material, the body will resorb this natural substance at a rate
that closely mimics that of human bone. Usually within several weeks time, the
OSTEOSET(R) material gradually is replaced by human bone, leaving little
evidence of it's presence. OSTEOSET(R) encourages bone cells to regenerate new
bone tissue within and upon its surfaces which is a further benefit to the
patient. Another benefit of this material is that during the healing process the
material is visible on x-ray so it can easily be seen by the surgeon to verify
graft placement and healing rates.
The properties of OSTEOSET(R) Bone Graft Substitute also make it
particularly attractive for use in children. Because children do not have as
much available bone stock as adults, the surgeon may not be able to harvest
enough bone from the child and may need to add a bone substitute. OSTEOSET(R)
pellets are ideal for this purpose.
Patients who have bone infections will also benefit from OSTEOSET(R).
Because OSTEOSET(R) is resorbed by the body, it does not remain in the body for
extended periods of time and therefore cannot serve as a host for infectious
organisms. Since OSTEOSET(R) is resorbed in several weeks and because it does
not support infectious agent growth, it is the only synthetic bone void filler
approved for use in infected areas of the body.
The Company is also developing additional applications for its OSTEOSET(R)
products. Pending longer term FDA approval and approval in some foreign
countries, the Company is developing OSTEOSET(R) products mixed prior to
implantation with appropriate drugs that could be used to treat bone infections.
OSTEOSET(R) T, a product medicated with Tobramycin (antibiotic), was released
this year for sale in Australia and Canada. Early clinical results indicate the
product has been very successful. The Company expects to receive clearance to
market this new product in Europe in 1998.
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The advantages of having a bone void filler which can be mixed with an
antibiotic will help revolutionize the treatment of several bone problems which
exist today. Currently, orthopaedic surgeons create small beads of bone cement
and soak these with antibiotic agents. They then implant this string of beads
within the infected site and hope to get some reduction in infection by
releasing the antibiotics close to the site of infection. Unfortunately, the
infection must be treated for several days. This method results in only about 72
hours of antibiotic therapy to the infected site whereas the antibiotic is not
released in a controlled manner. You can therefore have a lot of antibiotic
released quickly but because the amount is not controlled or prolonged, the
infectious organisms are not controlled. The second problem with this method is
that the surgeon must go back into the surgical site to remove the bone cement
beads since they are not bioresorbable.
The intent of the surgeon is to try and provide a slow, controlled release
of antibiotics at the site of the infection because the blood supply to the bone
is poor and thus systemic antibiotics frequently do not reach the infected site
in large enough quantities to be therapeutic. This is one reason why bone
infection (osteomyelitis) is a serious condition in the orthopaedic community.
OSTEOSET(R) has proven to be an ideal material for the delivery of
antibiotics to an infected area of bone. When OSTEOSET(R) is impregnated with
Tobramycin, and placed in the infected wound, it releases the antibiotic in a
controlled and prolonged rate which is effective in reducing the infection at
the site. Because the material is bioresorbable, the surgeon does not have to
reopen the site to remove the OSTEOSET(R). These properties of OSTEOSET(R) make
it an exciting potential carrier for other types of chemical agents which can be
placed within the wound to effect treatment of other conditions.
OsteoBiologics Implants
OsteoBiologics, Inc., a San Antonio, Texas based company in which the
Company has an ownership interest, is developing a series of bioabsorbable,
polylactate and polyglycolic acid implants that, pending FDA approvals, may be
effective in a variety of uses including: a bone void filler; a method to induce
the repair of articular cartilage defects (both focal defects and for
resurfacing) by growing articular cartilage in vivo; a treatment for delayed
unions and non-unions in fractures; and the repair of bone voids resulting from
tumor and cyst removal and from thinning bone. OsteoBiologics intends to seek
regulatory approval for its first commercial products, the bone void fillers, in
1998. OsteoBiologics also has a unique
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patented electronic instrument for measuring the physical characteristics of
soft tissue such as cartilage which employs a reusable, sterilizable electronic
hand piece and disposable probes. This product is still in its prototype stage
and the Company expects it to be available for commercial distribution pending
approval in 1998.
Collagen based Tissue Engineering
The Company entered into a joint venture agreement in mid 1996 with TEI, a
Boston, Massachusetts company that develops collagen-based technology. The joint
venture company, Orthopaedic Tissue Technology, L.L.C.("OTT"), a Delaware
limited liability company, will develop and distribute biological products for
musculoskeletal applications. OTT products under development include collagen
based scaffolds used for ligament and tendon reconstruction and for cartilage
regeneration, and a calcium phosphate based bone cement which offers great
strength for fracture fixation and anchoring certain implants. In 1998, OTT
began pre-clinical trials of its first products, a biologically engineered patch
ligament and a resorbable bone cement. The periosteal patch is a thin collagen
membrane that is cross linked and functions as a patch on the periosteum. It can
be used to assist in sites where OSTEOSET(R) pellets are not self contained. The
dura patch is also a thin collagen membrane that is bi-phasic which means that
one side adheres to tissue and the other side does not adhere to tissue. The
dura patch protects the dura from adhesion to surrounding tissue.
Trauma
Trauma implants encompass a wide variety of screws, plates, rods, wires,
cables and pins all utilized to fix or support bone that has been fractured due
to accidental or surgically induced trauma. These devices serve to orient and
stabilize bone until healing can occur. The CONCISE(TM) Compression Hip Screw
System and the companion Medoff Sliding Plate enable the orthopaedic surgeon to
treat most types of proximal and supracondylar femoral fractures. The TYLOK(TM)
High Tension Cerclage Cabling System is used for fixation and stabilization of
long bone fractures and offers distinct advantages over the competitive devices.
The stainless steel CANNULATED PLUS(TM) Screw System is used for stabilization
of fracture fragments. The Company has also developed its MAGELLAN(TM)
Intramedullary Nailing System, a unique modular nailing system which allows for
significant inventory reduction compared to other nailing systems. The
MAGELLAN(TM) system also includes a unique targeting device for placement of
distal screws which obviates the need for extended x-ray exposure for both
physician and patient in locating the distal screw holes in the nail.
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On March 11, 1998, the Company signed a Letter of Intent to sell its trauma
assets, patents, and agreements for approximately $4 million, a Royalty
Agreement, and 5% of the voting common capital stock of the purchasing entity.
Closing is expected to be on or before June 15, 1998.
Arthroscopy
The Company currently offers for sale the ANCHORLOK(TM) Soft Tissue Anchors
which are used in a variety of joints for reattaching ligaments and tendons (or
other soft tissue) to bone where tearing or separation has occurred. The
Company's anchors have a patented self- tapping thread, superior holding
strength and can be removed easily giving the surgeon more surgical options. In
1997, the Company introduced the ANCHORLOK(TM) RL Soft Tissue Anchor, a lower
cost version of the device which is not prethreaded with sutures. The Company
has offered this product line and its portfolio of uncommercialized arthroscopic
products for sale.
Spine
The Company currently offers a number of innovative products for the
fixation of the spine.
In the thoracic and lumbar spinal fixation areas, the Company offers the
WRIGHTLOCK(R) and VERSALOK(R) Spinal Fixation Systems. Additionally, the Company
intends to commercialize in 1998 the MILLENNIUM(TM) anterior cervical plating
system developed by Gary K. Michelson, M.D.
The MILLENNIUM(TM) anterior cervical plating system is used for
stabilization during fusion of the cervical spine. This system's unique
qualities include preassembled locking screws, no "fiddle factor" "watchmaker"
parts, an innovative self-tapping screw that maximizes bone purchase while
minimizing the incidence of stripping, and a low profile anatomically correct
plate. This fusion procedure is performed for degenerative disease, trauma, and
tumors. The MILLENNIUM(TM) system has received FDA approval and a limited
clinical release is expected in the second quarter of 1998.
For scoliosis and other spinal instabilities the Company offers the
WRIGHTLOCK(R) posterior fixation system. The patented system, under license from
Zimmer, Inc., is based on a high strength, stainless steel rod technology with
Morse-taper locking mechanisms that provide a low-profile system. The profile
(i.e., the height of the implant) is important in the scoliosis market that
principally affects teenaged and pre-teenaged girls. The system offers a
comprehensive selection of instruments that are designed to adapt to a wide
range of surgical strategies including a standard derotation set and an outboard
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correction set (OCS(R)) for distraction. The OCS(R) was developed by Dr. Ben
Allen, Chief of Surgeries, Hospital for Crippled Children in Greenville, South
Carolina. WRIGHTLOCK(R)'s patented tapered locking mechanism significantly
reduces operating time and eliminates the need for complex set screw fixation.
The Company received FDA clearance for its VERSALOK(R) low back fixation
system and began marketing the product in 1997. Working with a select group of
spine surgeons, including John R. Johnson, M.D. and the late David Selby, M.D.,
the Company developed this low back fixation system that features a
revolutionary polyaxial screw with a tapered locking design, requiring no set
screws or locking nuts. The advanced design features of its components and
instrument set ensure the maximum in intraoperative flexibility, ease of use,
and the quickest assembly. In clinical use, the system is very easy to set up
and lock in place and, if required, easy to remove, and offers significant
savings in operative time over competing systems. The Company plans to offer the
VERSALOK(R) system in a titanium alloy.
The Company also has under development a posterior cervical plating system,
an anterior interbody fusion cage, and a Generation II Rod to Rod Coupler for
use with both WRIGHTLOCK(R) and VERSALOK(R).
The company has offered its spinal assets related to these products for
sale.
Marketing and Distribution
Overview and U.S. Marketing and Distribution. The Company markets its
products in the United States through a network of 213 sales personnel,
including 45 distributors (the "Distributors") and 168 commissioned sales
representatives (collectively, the "Sales Organization"), serving every state in
the country. The Distributors, who are mostly independent contractors, and the
sales representatives sell the Company's orthopaedic implants at commission
rates that the Company believes are competitive with those paid by other
orthopaedic manufacturers.
Management believes that the Distributors and their surgeon relationships
are a critical component of the Company's success. For distribution purposes,
the Company divides the domestic market geographically into 46 territories, each
of which is controlled by a Distributor or Distributors authorized to sell the
Company's products.
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The success of these sales professionals depends primarily upon
high-quality service levels, technical proficiency and strong surgeon
relationships. As such, the Company's sales organization undergoes significant
product and sales training with courses conducted throughout the year. The
Company historically has focused its marketing efforts in the United States,
with approximately 73% of the Company's revenue derived domestically during
1997.
In early 1997, the Company purchased the assets of one of its distributors,
Outcome Medical, Inc., and its related companies ("OMI"). In late 1997, the
Company decided to enter into an agreement with OMI to terminate the Asset
Purchase Agreement and to return those organizations to independent commissioned
sales agents. This agreement was executed January 22, 1998.
International Marketing and Distribution. The Company's international sales
revenue represented approximately 27% of the Company's overall sales for 1997.
Management intends to continue to expand its international distribution and
marketing capabilities. The Company's international marketing and distribution
is accomplished primarily through independent distributors engaged in
distribution in Japan, South and Central America, Australia, Europe and Asia,
with the Company distributing products in France and Canada through wholly owned
subsidiaries. Depending on the market size and conditions, the foreign
independent distributors are granted either exclusive or non-exclusive rights to
distribute the Company's products, with a majority being exclusive distributors.
Competition
The orthopaedic implant industry is highly competitive and dominated by a
number of large companies with more resources than the Company. Competitive
factors include service, product design, depth of product offering, physician
recognition and price. The Company believes its future success will depend upon
its ability to be responsive to the needs of its customers and on continued
improvement and development of novel products designed to solve previously
unaddressed orthopaedic problems. The Company believes the majority of the
market share for the Company's products are held by Biomet, Inc., Zimmer, Inc.
(a subsidiary of Bristol-Myers Squibb Company), Johnson & Johnson Professional,
Inc. (a subsidiary of Johnson & Johnson), Howmedica, Inc. (a subsidiary of
Pfizer Inc.), DePuy (a subsidiary of Corange), Smith & Nephew Orthopaedics, Inc.
(a subsidiary of Smith & Nephew Ltd.), Osteonics, Inc. (a subsidiary of Stryker
Corporation), Sofamor Danek Group, Inc. and Sulzer Orthopaedics, Inc. (a
subsidiary of Sulzermedica).
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With respect to large joint implants (hips and knees) the competitors
listed above represent approximately 94% of the hip implant market and 92% of
the knee implant market. In addition, there are several manufacturers that
compete only in the global small joint orthopaedic implant market. The Company's
most significant competitor in this market has less than a 10% market share.
Manufacturing and Quality Control
Almost all of the Company's orthopaedic implants and instruments are
manufactured at its headquarters in Arlington, Tennessee, and through a select
group of qualified contract manufacturers. The Company's manufacturing
operations are subject to Good Manufacturing Practices ("GMP") and other
regulations stipulated by the FDA and other relevant regulatory organizations,
such as the Environmental Protection Agency ("EPA") and Occupational Safety and
Health Agency ("OSHA"), and similar state and foreign agencies and authorities.
In early 1997, the Company's facilities were inspected and cleared for GMP
compliance by the FDA.
In December of 1995, the Company's research and development, manufacturing,
and distribution operations became certified to the standards established by the
International Standards Organization ("ISO"). This "ISO 9000" certification and
process assures a level of product quality by regulating the processes of
product development and manufacturing. Approximately 80 countries have currently
adopted ISO 9000 for medical products, thereby enabling ISO 9000 registered
companies to sell their products in these countries without the additional
burden of individual country regulation. Manufacturers so certified are
recognized by the European Economic Community ("EEC") as maintaining high levels
of quality in products and service and their products are granted the CE mark
which permits their importation into and sale within the European Economic
Community. The renewal of ISO certification occurs annually via an on-site
inspection. The Company retained ISO certification after the 1997 audit and has
applied CE marks to many key products.
The Company utilizes comprehensive, integrated systems for manufacturing,
planning, scheduling, in-process testing, inspection and measuring of all
implants and components. The Company's current facilities have sufficient
capacity to meet its projected, near-term growth of its orthopaedic implant and
instrument business.
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Government Regulations
The Company and substantially all of its products are subject to the
provisions of the Federal Food, Drug and Cosmetic Act of 1976, as amended by the
Medical Device Amendments of 1976 and the Safe Medical Device Act of 1990, as
amended in 1992 (the "Safe Medical Device Act"). The Company also is subject to
various foreign laws governing medical devices. All of these regulations are
designed to ensure the safety and effectiveness of medical devices. In addition,
certain of these regulations require the Company to maintain certain standards
and procedures with respect to the manufacturing and labeling of products. All
of the Company's records and manufacturing facilities are subject to inspection
on a regular basis by the FDA. The Company's facilities were inspected by the
FDA in early 1997. The different levels of FDA compliance include: Official
Action Indicated (OAI), Voluntary Action Indicated (VAI), and No Action
Indicated (NAI). Companies that receive an OAI may have official action taken
against them including product approval delays, products taken off the market,
seizing of their products, heavy fines or imprisonment. Companies that receive
VAI have voluntarily agreed to correct any problems the FDA has found. The
result of the FDA inspection determined that the Company was in compliance with
all FDA rules and regulations and was therefore considered NAI. Additionally,
the Company's 1997 audit by the ISO, the governing body for medical devices in
the EEC, determined that the Company was in compliance with all EEC regulations
preserving the Company's ISO status.
The FDA classifies medical devices as Class I, II or III. Class I devices
generally do not require pre-marketing approval. In general, Class II and III
devices require pre-market FDA approval unless they are found to be
"substantially equivalent" to products already in the market. For "substantially
equivalent" products, the provisions of Section 510(k) of the Federal Food, Drug
and Cosmetic Act provide for an exemption to the pre-market approval process.
The Company's orthopaedic implants are generally Class II devices. All of the
Company's Class II devices being marketed are cleared for marketing under the
provisions of Section 510(k). The Company currently manufactures no approved
Class III devices, which require more extensive FDA approvals. However, as the
Company designs and develops more novel medical devices, the Company may have
difficulty in establishing that such device is "substantially equivalent" to
another legally marketed device and thereby may be unable to obtain 510(k)
clearance to market a new product. The Company intends to pursue the manufacture
of Class III devices, which would require extensive FDA pre-market approval
before commercial distribution. There can be no assurance that the Company would
be successful in obtaining regulatory approval of such Class III devices.
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At any given time, the Company has a number of medical devices that are in
various stages of development, and therefore, subject to FDA clearance
procedures that may cause delays in the commercialization of these devices. Any
future devices developed by the Company are likely to be subject to FDA
registration, notification, pre-market approval, performance standards or other
FDA controls that could have an adverse effect on the commercialization of such
products. Additionally, any changes in FDA or foreign medical device laws could
impose new regulatory burdens on medical device sales.
During 1997 the Company received 510(k) clearance on 18 new products. In
1996, the Company received regulatory approval (SHONINS) in Japan to distribute
key products. The Company also enhanced its quality control process by
establishing a pre-production quality assurance program. The Company has
converted to the new FDA Quality Systems Regulations and to the new Medical
Device Reporting regulations.
The Safe Medical Device Act grants the FDA the authority to require
manufacturers to conduct post-market surveillance on most permanent implants and
devices that potentially present a serious risk to human health. The FDA is also
given the authority to require manufacturers of certain devices to adopt device
tracking methods to enable patients to receive required notices pertaining to
the devices they receive. Such tracking requirements may increase the Company's
administrative procedures relating to the sale of many of the Company's implants
should the FDA require post-market surveillance of the Company's products.
Despite the fact that the FDA has not yet promulgated all of the regulations
needed to fully implement the Safe Medical Device Act, the Company does not
believe compliance with that act will have a material adverse affect on the
Company or its operations.
Research and Product Development
The Company's research and development activities and capabilities are
located primarily in Arlington, Tennessee. There is a small development activity
for arthroscopy products at Questus Technologies, Inc. in Marblehead,
Massachusetts and a small development activity for the medical grade calcium
sulfate products in Libertyville, Illinois. Both are in leased space. Over 44
employees are active in the areas of Applied Research, Biomechanical
Engineering, Materials Testing and Analysis, Advanced Manufacturing Technology,
Implants and Instrument Development Techniques, Research, Product Development
and New Technology Exploration. The Company's applied technology group maintains
laboratories capable of performing
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materials characterization, product testing and evaluation in simulated clinical
use environments, including fatigue testing, wear testing and materials
analysis.
In addition to classic laboratory testing and evaluation of new products
and technologies, the Company conducts pre-clinical studies at a number of
university and medical center locations, as well as clinical research to
evaluate the success and outcome of new products and technologies.
The Company believes that custom implants built to prescription from a
surgeon, serve as a specific treatment for a patient, but also help to explore
new and innovative products for general use. For example, initially designed as
a custom implant for limb salvage, the Company's S.O.S.(R) (Segmented
Orthopaedic System) now has wide spread application for oncology patients and
severe revision cases. During 1997 the Company shipped approximately 230
individual patient devices, with an average time of manufacture of less than 15
days. In addition to custom implants, the Company provided surgeons with many
options for custom instrumentation to facilitate their surgical techniques.
The Company's commitment to research and development is evidenced by the
expenditures it makes each year. Research and development expenses were
approximately $12.7 million in 1995, approximately $13.2 million in 1996, and
approximately $11.6 million in 1997. The Company believes the research and
development expenses represent a commitment which is significantly higher as a
percentage of sales than all of its major competitors.
Principal Customers
The Company currently markets its products to health care professionals and
hospitals in the United States and in many major countries outside of the United
States. Key customers include orthopaedic surgeons specializing in total joint
replacement, sports medicine, spinal surgery and traumatology. The Company has
approximately 4,000 active hospital and physician customers, with no single
customer representing more than ten percent of the Company's consolidated sales.
The Company currently does not conduct any business directly with foreign
governments, with such sales being made through the Company's established
distribution network of independent contractors.
Raw Materials
The majority of the Company's raw material purchases are comprised of four
principal materials that are generally available, in
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implant grade, from a variety of sources with various lead times. Cobalt chrome
is purchased in ingot form and cast into implants and trials. Titanium, both
commercially pure and alloy grade, is purchased in bar stock form and machined
into implants and instruments. Ultra high molecular weight polyethylene, also
purchased in bar stock form, is machined into implants for weight bearing and
articulating surfaces. Stainless Steel 17-4 precipitation hardened is purchased
in both ingot and bar form and is cast or machined into instruments, and
stainless steel 22-13-5, 22-13-10, and 316L is purchased in wrought bar form
that is machined into implants. In addition, the Company's small joint implants
require silicone that is purchased as processed extruded elastomer blocks.
The Company has not experienced a shortage of raw materials and does not
anticipate a shortage in the future. In light of certain businesses increasing
reluctance to offer raw materials intended for medical devices because of
product liability concerns, there can be no assurance of continued supply or
that finding an alternative source would not cause a delay in the Company's
manufacturing process.
Environmental
The Company believes it is operating in material compliance with applicable
regulations required by the State of Tennessee and the EPA. The Company's
objective is to operate in a clean and safe environment, minimize the generation
of hazardous and non-hazardous waste and promote environmentally sound
recycling, reuse and reclamation of waste. As part of the Company's recognition
of resource protection, its level of recycling has been increased. The Company
does not expect to incur a material amount of capital expenditures in order to
maintain its environmental compliance. Furthermore, the Company believes that
compliance with these regulations will not materially impact either the
Company's earnings or competitive position.
Insurance
The Company maintains comprehensive and general liability insurance,
including product liability, with coverage up to $100,000,000 in the aggregate.
The Company maintains a $250,000 per incident and $750,000 aggregate self
insured retention. Although the Company has not experienced any significant
claims to date, there can be no assurance that the Company's insurance will be
adequate to cover any claims that may be asserted in the future. Although Dow
Corning Corporation has contractually agreed to indemnify the Company for all
products manufactured by Dow Corning prior to the Acquisition (other than
certain small joint implants purchased by the Company and sold after the
Acquisition), there can be no guarantee that such indemnity
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will continue in light of Dow Corning's bankruptcy filing; the Company does not
maintain insurance for those claims.
The Company also maintains liability insurance covering directors and
officers with coverage up to $5,000,000. There is no deductible per officer or
director per event and a $100,000 deductible for the Company per event. The
Company also carries insurance coverage for all real and personal property
including business interruption, and coverage for workers' compensation, crime
and fiduciary liability in amounts that management believes to be adequate.
Patents and Trademarks
As of January 19, 1998, the Company owned 81 patents and had applications
pending in the United States and major countries throughout the world for
seventeen additional inventions. The Company has purchased, licensed or has
distribution rights for the design, manufacture and distribution of certain
products. See "Business-- Principal Products." The Company currently has 36
registered trademarks and applications pending on 11 other marks in the United
States and major countries throughout the world. The Company uses its patents
and trademarks throughout the world in connection with its business operations.
As necessary, the Company vigorously protects its patents and trademarks both
domestically and internationally.
Royalty and Other Payments
The Company has various agreements with unaffiliated entities and persons
that provide the Company with certain rights to manufacture and market certain
orthopaedic products developed independently by such entities or persons or
jointly with the Company. The agreements provide for royalty payments ranging
from less than 1% to 10% of the net selling price (as defined in such
agreements) of those certain orthopaedic products. In addition, the Company has
a number of consulting agreements pursuant to which distinguished surgeons
evaluate the Company's new and existing products in exchange for a consulting
fee.
Seasonality
The Company's revenues are subject to some seasonality. Since the majority
of implant surgery is elective, the warm weather months traditionally yield
lower sales volumes than do the late fall and winter months.
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Employees
As part of an overall plan to increase profitability and improve cash flow,
the Company has effected a plan to significantly reduce its workforce. From a
high of 671 in August of 1997 the Company has reduced its workforce to 559
full-time employees as of March 13, 1998, including 524 at it Arlington
operations, 6 in regional operations and 29 outside the United States. The
Company's employees are not covered by any collective bargaining agreements.
Overall, the Company believes that its relationship with its employees is good.
ITEM 2. PROPERTIES.
The Company's headquarters and manufacturing operations are located in
leased facilities in Arlington, Tennessee, which is located near Memphis. The
Company's facilities consist of an aggregate of approximately 168,000 square
feet, approximately 53,000 of which are utilized for manufacturing and
approximately 45,000 of which are utilized as a distribution center with the
balance being utilized for office space.
The acquisition and construction by the lessor of the Company's
manufacturing facilities were financed through the issuance by the lessor of
industrial development bonds, which have been paid in full. The base rent
payable under the lease for the initial term was the amount required to meet the
debt service requirements of the bonds. Accordingly, no further base rent is
payable during the initial term of the lease. The initial term of the lease
expires in 1999. The Company has the option to renew the lease for five
additional ten year terms at a base rental of $6,000 per year. In addition, the
Company has the option to purchase the facilities at a price of $100 at any time
prior to the expiration of the lease in 1999.
The lease for the Company's office facilities provides for the payment of
annual rent of $5,000, plus the lessor's expenses. The term of the lease expires
in 2005. The Company has the option to purchase the facilities at a price of
$101,000 at any time prior to the expiration of the lease in 2005.
The acquisition and construction by the lessor of the Company's
distribution center was also financed through the issuance by the lessor of
industrial development bonds, which have also been paid in full. The base rental
under the lease was the amount required to meet the debt service requirements on
the bond. Accordingly, no further base rent is payable during the term of the
lease. The term of the
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lease expired on the original maturity date of the bonds. The Company has the
option to purchase the facilities at a price of $1,000 at any time. The Company
added 5,000 square feet as an extension to the original distribution center
structure during 1995.
The Company leases approximately 4,000 square feet in Marblehead,
Massachusetts for its Questus facility that provides for monthly rent of
$10,860. The facility is used for research and development and office space.
ITEM 3. LEGAL PROCEEDINGS
Mitek Surgical Products, Inc. ("Mitek"), has alleged in the Federal
District Court for the Northern District of California that the Company's
ANCHORLOK(R) soft tissue anchor infringes its patent. That court recently
rendered an opinion of non-infringement in favor of the Company, which opinion
was reversed on November 3, 1997, after reconsideration by the Court. On July
18, 1997, Howmedica, Inc. alleged in the Federal District Court for the District
of New Jersey that certain of the Company's products infringe its patent related
to a type of porous coating and seeks unspecified money damages. The Company is
defending that claim. On August 22, 1997, Osteonics, Inc. alleged in the Federal
District Court for the District of New Jersey that the Company's BRIDGE(R) Hip
System infringes its patent and seeks money damages and injunctive relief. The
Company is defending that claim.
On April 3, 1995, the Company (and ORTHOMET(R), Inc., a wholly owned
subsidiary at the time that has subsequently been merged with and into the
Company) was notified that it had been sued by Joint Medical Products
Corporation (which was purchased by Johnson & Johnson Professional, Inc.) in the
United States District Court of the District of Connecticut seeking damages for
the alleged infringement of its patent (U.S. Pat. No. 4,678,472, the "472
Patent") by certain of the Company's acetabular cups and liners. Pending the
resolution of an interference proceeding in the U.S. Patent and Trademark Office
regarding the '472 Patent by British Technology Group Ltd. ("BTG"), such
complaint was dismissed without prejudice. In early November 1996, the Company
was notified that the interference proceeding was resolved. Joint Medical
Products Corporation filed another complaint against the Company on January 28,
1997. A Stipulation of Dismissal without prejudice was filed in this case with
the court on December 22, 1997. A tolling agreement between Joint Medical
Products Corporation and the Company dated as of April 3, 1995 regarding these
claims of infringement remains in effect. BTG has offered the Company
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a license of the '472 Patent and a corresponding reissue patent. The Company
believes that it has valid defenses to claims of infringement of the '472 Patent
and to the reissue patent.
Management does not believe the outcome of any of these matters will have a
material adverse effect on the Company's financial position or results of
operations.
DCW, pursuant to the Acquisition agreements, retains liability for matters
arising from certain conduct of DCW prior to the Company's acquisition on June
30, 1993, of substantially all the assets of the large joint orthopaedic implant
business of DCW. As such, DCW has agreed to indemnify the Company against all
liability for all products manufactured prior to the Acquisition except for
products provided under the Company's 1993 agreement with DCW pursuant to which
the Company purchased certain small joint orthopaedic implants for worldwide
distribution. However, the Company was notified in May 1995 that DCW, which
filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code, would no
longer defend the Company in such matters until it received further direction
from the bankruptcy court. Since then DCW has filed various proposed plans of
reorganization that provided that all commercial creditors be paid 100% of their
claims, plus interest. The plans did not however indicate whether DCW would
affirm or reject the Acquisition agreements. No plan of reorganization has yet
been approved. Accordingly, there can be no assurance that Dow Corning will
indemnify the Company on any claims in the future. Although the Company does not
maintain insurance for claims arising on products sold by DCW, management does
not believe the outcome of any of these matters will have a material adverse
effect on the Company's financial position or results of operations.
The Company is not involved in any other pending litigation of a material
nature that would have a material adverse effect on the Company's financial
position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.
As of August 11, 1997, the Company received the written consent of the
Board of Directors and a majority of the holders of both the Series A Preferred
Stock and the Class A Common Stock to increase the reserve for shares to be
issued under the 1994 Distributor Stock Option Plan by 70,000 shares and under
the 1993 Stock Option Plan by 370,000 shares.
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PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
The Company's Class A Common Stock currently is not publicly traded, and,
as such, market value quotations are unavailable. There were 361 registered
holders of Class A Common Stock as of March 13, 1998. The Company has never paid
dividends on its Class A Common Stock and does not expect to pay any cash
dividends in the foreseeable future. The Company currently intends to retain its
earnings, if any, for future operations and expansion of its business. Any
decisions as to the payments of dividends in the future will depend on the
earnings and financial position of the Company and such other factors as the
Board of Directors deems relevant. In addition, the Company's indenture with
State Street Bank and Trust Company, as successor to First National Bank of
Boston, on providing for the issuance of the Company's 11 3/4% Series D Senior
Secured Notes, due July 2000 (the "Indenture"), the Company's Restated
Certificate of Incorporation, the Company's Series B Preferred Stock Purchase
Agreement and Class A Common Stock Warrant Agreement dated as of July 29, 1994
with the California Public Employees Retirement System ("CalPERS"), as amended,
and the Class A Common Stock Warrant Agreement dated as of September 25, 1995
with CalPERS (collectively, the "CalPERS Agreement") and its Credit Agreement
dated September 13, 1996, by and between the Company and Sanwa Business Credit
Corporation (the "Credit Agreement"), substantially limit the payment of cash
dividends on the Company's capital stock.
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<TABLE>
ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial data of the Company and its subsidiaries
(the "Successor") and of the DCW medical device business (the "Predecessor")
should be read in conjunction with the financial statements and the notes
thereto included in Item 8.
(in thousands, except per share data and ratio)
<CAPTION>
Predecessor Successor
=========== ======================================================================
JAN 1, JUN 30, Year Year Year Year
through through Ended Ended Ended Ended
JUN 30, DEC 31, DEC 31, DEC 31, DEC 31, DEC 31,
1993 1993 1994 1995 1996 1997
<S> <C> <C> <C> <C> <C> <C>
Operating Data:
Net sales $35,033 $ 43,027 $ 95,763 $ 123,196 $ 121,868 $ 122,397
Net income (loss) 437 (2,572) (49,380) (6,492) (14,589) (22,572)
Loss per common share -- (.41) (6.10) (2.24) (3.90) (4.38)
Balance Sheet Data:
Total assets $72,691 $ 113,497 $ 154,551 $ 174,371 $ 166,326 $ 153,083
Long term debt 108 84,605 84,983 84,462 84,668 85,104
Mandatorily redeemable
Series B Preferred -- -- 47,658 46,757 59,959 70,511
Redeemable Convertible
Series C Preferred -- -- -- 20,548 24,995 29,442
Parent company
investment 68,029 -- -- -- -- --
Stockholders' equity -- 11,602 (25,502) (25,177) (58,506) (97,010)
Ratio of earnings to
fixed charges and
preferred dividends -- (A) (A) (A) (A) (A)
<FN>
(A) Earnings were inadequate to cover fixed charges, preferred dividends
and accretion of preferred stock by $3.6 million, $61.7 million, $26.3
million, $35.3 million and $41.2 million, respectively, for the period
from June 30, 1993 through December 31, 1993 and for the years ended
December 31, 1994, December 31, 1995, December 31, 1996, and December
31, 1997.
</FN>
</TABLE>
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
The Company's 1997 performance failed to meet management's expectations.
The net sales of its knee product lines were down and although its sales of hips
and extremity products were up, the expected growth in those lines and in the
Company's spine, trauma and arthroscopy lines was not realized. However, in late
1997 and early 1998 the Company effected various initiatives which should result
in positive trends in the reduction of general and administrative expenses, the
reduction of selling expenses, an increase in gross margins and improved cash
flow. While the Company's 1997 sales were relatively flat over the prior year,
the Company expects renewed sales growth in late 1998 as its biologic products
gain wider exposure and ADVANCE(R) knee product line additions become available.
Beginning in August of 1997 the Company commenced a plan to significantly
streamline its operations and reduce its operating expenses. For example, the
Company sought to significantly reduce its workforce. Accordingly, through
terminations and attrition, the Company's workforce has dropped approximately
20% from a high of 671 employees in August 1997 to 559 as of March 13, 1998. The
Company also reversed, as of December 31, 1997, the transaction whereby it had
purchased the assets and employment contracts of two of its distributors. That
initial purchase increased significantly the Company's selling expenses and its
reversal should have a favorable impact in 1998. Other initiatives should have
similar results.
In early 1998, with the introduction of new management, the Company also
embarked on a new strategy of concentrating its resources and working capital in
its business segments with the greatest potential for return including its knee
and hip (large joint) business segments, its extremity business (products for
the shoulder, arms, hand and feet) and its growing business related to its
biological portfolio. Toward that goal and in the first quarter of 1998, the
Company established a separate biologics division for the purpose of expanding
the development, marketing, and sales of its biologic portfolio of products.
Also, the Company has decided to seek to divest its assets related to its spine,
trauma and arthroscopy businesses. In March 1998, the Company entered into a
letter of intent to sell its trauma assets.
Also in 1997 the Company, through an exchange offer of its Series B Senior
Secured Notes, (see Note 7 of the Financial Statements) eliminated those sinking
fund payment obligations which
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otherwise would have been due on July 1, 1998 and 1999. The Exchange Offer
provides the Company with additional flexibility in addressing its capital
structure. Of course, the Company is, and will continue to be, highly leveraged
with attendant risks. The Company's ability to meet its debt service
obligations, to achieve its financial covenants and to reduce its total debt
will be dependent upon the Company's future performance, which will be subject
to general economic conditions and to financial, business and other factors
affecting the operations of the Company, many of which are beyond its control.
There can be no assurance that the Company's future performance will not be
adversely affected by such economic conditions and financial, business and other
factors.
RESULTS OF OPERATIONS
Year Ended December 31, 1997 Compared With Year Ended December 31, 1996
Sales. In 1997 sales remained relatively flat for the Company at $122.4
million compared to $121.9 million in 1996. Sales of knees were lower in 1997
than the previous year by $4.5 million or 6%, attributable to a decline in
ADVANTIM(R) Knee sales offset by an increase in sales of the ADVANCE(R) Knee
products.
Hip sales were were up 2.0% from 1996 to $28.9 million, extremity products
increased 3.4% to $11.0 million. Biologics sales increased significantly from
$0.3 in 1996 to $2.6 million in 1997. Spine, trauma and arthroscopy sales were
$4.4 million.
The Company's international sales were strong in 1997 with overall sales of
$33.1 million compared to $30.4 million for 1996. Every product line experienced
growth in 1997 internationally. Sales of knees were $20.8 million or $1.1
million (5.3%) higher than in 1996. ADVANTIM(R) knee sales contributed to this
growth with a sales increase of $0.2 million compared to the same period in
1996.
Domestic sales decreased by $2.1 million in 1997 when compared to 1996
principally due to the net decline in knee sales.
Cost of Goods Sold. Cost of goods sold increased from $44.4 million in 1996
to $46.7 million in 1997 or 5%. This increase was due primarily to a higher
percentage of international sales and instrument sales when compared to 1996.
These have a higher cost of sales as a percentage of sales.
Selling. Selling expenses increased by $3.6 million or 7% in 1997 to $51.0
million. This increase primarily resulted from the on-
Page 29 of 119
<PAGE>
going expenses related to the previously independent distributorships which were
purchased by the Company earlier in 1997, the expenses due to the reorganization
of operations in the New England territories which also occurred earlier in the
year and the reclass to selling of guaranteed royalties from Research and
Development where they were included during 1996.
General and Administrative. General and Administrative expenses of $20.1
million were higher in 1997 by $0.8 million from the previous year. However, net
of expenses related to the third quarter Exchange Offer ($2.8 million) and the
reduction in force ($0.2 million), general and administrative expenses decreased
when compared to the prior period. This decrease was primarily attributable to
cost reduction measures instituted during the third quarter of 1997 which began
having a favorable effect during the fourth quarter of the year.
Research and Development. Research and development expenses decreased in
1997 to $11.6 million which was $1.6 million (12.0%) below 1996 spending.
Approximately half of this decrease was due to the reclassification of
guaranteed royalties from research and development in 1996 to selling in 1997.
The additional reduction was primarily attributable to decreased outside
research studies and clinical costs.
Other. Equity in loss of investment of $1.2 million represented a full year
of the Company's 50% share of the expenses incurred related to the joint venture
with TEI. During 1996 the joint venture was only in existence for the second
half of the year which was the primary reason for the increase of $0.7 million
in 1997.
Interest expense net of interest income increased by $1.1 million to $13.1
million in 1997. This increase was primarily due to the higher interest rate
paid on the new bonds due to the Exchange Offer and increased interest paid on
the Company's line of credit because of higher usage of these funds.
Other income/expense increased to $1.3 million in expense in 1997 from $0.4
million of income in 1996. This unfavorable swing of $1.7 million was primarily
due to unfavorable currency exchange rates, non recurring income due to the sale
of the Company jet in 1996, a non-recurring tax refund in 1996 and expense in
1997 due to the OMI asset purchase settlement.
For the years ended December 31, 1997 and December 31, 1996 earnings before
interest, taxes, depreciation, and amortization ("EBITDA") are detailed in the
table below. The EBITDA totals both before and after certain adjustments are
shown:
Page 30 of 119
<PAGE>
<TABLE>
<CAPTION>
December 31,
-------------------------------------
1997 1996
------------- -------------
<S> <C> <C>
Operating Loss $ (8,233) $ (3,055)
Depreciation and Instrument Amortization 12,926 11,272
Amortization of Intangibles 3,364 3,266
Amortization of Other Assets 533 266
------------ -------------
EBITDA before Certain Adjustments $ 8,590 $ 11,749
Inventory Reserves and Other Related
Inventory Adjustments 8,450 4,852
Orthomet Inventory Step-Up* 0 992
Stock Contribution 1,093 934
------------- -------------
EBITDA after Certain Adjustments $ 18,133 $ 18,527
============= =============
<FN>
* Amount represents the flow through of the purchase accounting adjustment
in 1996 as it related to acquired Orthomet inventory.
</FN>
</TABLE>
Year Ended December 31, 1996 Compared With Year Ended December 31, 1995
Sales. In 1996, the Company posted sales of $121.9 million representing a
net sales decrease of approximately 1.1%, or $1.3 million, compared to its 1995
sales of $123.2 million.
Domestic sales for the year were $3.7 million or approximately 3.9% below
1995 while the Company's international sales grew by approximately 8.6% or $2.4
million over prior year. Sales in Europe, Latin America, Canada, and Asia grew
by $1.6 million (approximately 13.0%),$1.0 million (approximately 56.3%), $0.5
million (approximately 17.2%), and $0.2 million (approximately 10.1%)
respectively, offset primarily by lower than prior years' sales in Japan which
were due to prolonged transition in the change of distribution channels that was
initiated by the Company in order to better serve this market over the long
term.
Although total sales for 1996 decreased as compared to 1995, new product
line sales increased compared to prior year sales for the period in ADVANCE(R)
Knee ($2.6 million), trauma ($0.7) million), spine ($0.5 million), arthroscopy
products ($1.0 million) and biologics ($0.3 million). Those gains were offset by
decreased sales for the period in knees, other than ADVANCE(R) ($4.7 million),
hips ($0.9
Page 31 of 119
<PAGE>
million), and small joint products ($0.9 million). Despite the decrease in sales
dollars during 1996, unit sales of the Company's large joint products increased
during 1996 when compared to 1995. In large joints, particularly hips and knees,
the Company (and management believes the entire orthopaedic industry)
experienced a shift from higher priced porous coated products to lower priced
cemented products. While selling prices increased slightly in both cemented and
porous products, the mix of sales towards cemented designs resulted in a lower
average selling price per procedure.
Cost of Goods Sold. Cost of goods sold increased from $33.7 million in 1995
to $44.4 million in 1996, or approximately 32%. The $10.7 million net increase
was due to additional instrument reserving ($3.6 million) because of the
reclassification of surgical instruments to inventory as part of the Company's
revised instrument program designed to give the Company's independent
distributors better access to these instruments, increased variances charged to
cost of goods sold ($2.8 million), a reduction of the sales return reserve ($0.8
million), a higher level of sales of fully reserved products in 1995 resulting
in the reversal of inventory reserves during that year ($1.1 million),
additional product reserving in 1996 ($0.4 million) and increased manufacturing
costs ($1.8 million).
Selling. Selling expenses increased slightly in 1996 by $0.3 million when
compared to 1995. Although sales in 1996 were lower than 1995, commission
expenses, primarily guarantees, increased by $0.7 million in 1996 to $21.7
million. Royalties increased in 1996 to $2.0 million compared to 1995 royalties
of $1.4 million due largely to an increase on royalties being paid on the
Company's small joint orthopaedic products. Domestic marketing expenses
decreased in 1996 ($0.2 million) due primarily to lower literature, supplies and
advertising ($0.6 million) because of fewer new product launches in 1996 and
lower travel and entertainment expense ($0.7 million) offset by increased
payments ($0.6 million) due to distributor replacements and territory
realignments and increased salaries and benefits ($0.8 million) due to headcount
adds. International marketing expenses decreased by $1.7 million in 1996 when
compared to the same period in 1995. The reduced spending in 1996 resulted
primarily from shutdowns in Brazil ($0.5 million) and Australia ($0.2 million)
along with lower salaries and benefits in France due to the transition to a
non-employee sales force ($0.5 million), and decreases in the headquarters'
expenses in salaries, benefits, and travel ($0.3 million) which contributed to
this favorable variance year over year.
The Managed Care division of the Company spent $1.3 million in 1996 which
was $1.0 million more than was spent in 1995. This
Page 32 of 119
<PAGE>
spending was non-recurring as this division was closed in December, 1996.
General and Administrative. General and administrative costs decreased from
$23.4 million in 1995 to $19.4 million in 1996, or a decrease of $4.0 million
(approximately 17%). This decrease was attributable in large part to lower
intangible amortization ($1.2 million), reduced travel and entertainment
expenses due to the sale of the corporate jet and reduced overall travel ($2.1
million), lower insurance costs ($0.4 million), decreased legal fees ($0.4
million) and lower outside services ($0.4 million) offset by higher salaries and
benefits due to payment of the 1996 management bonus ($1.0 million).
Additionally lower professional fees in 1996 ($0.2 million) and international
favorable variances for the period due to lower spending in France ($0.2
million) contributed to the favorable year- over-year variance.
Research & Development. Research and development expenses increased $0.5
million from $12.7 million in 1995 to $13.2 million in 1996, or an increase of
approximately 4.0%.
Other. Equity in loss of investment ($0.5 million) represents the Company's
50% share of the expenses incurred related to the joint venture with TEI.
Amortization of a certain license arrangement obtained from TEI($0.3 million)
was the primary contributor to the joint venture loss.
Other income for the year ended December 31, 1996 increased $0.3 million as
compared to the same period in 1995 due primarily to favorable currency
conversion. Interest expense, net of interest income, increased from $11.3
million in 1995 to $11.9 million in 1996, an increase of $0.6 million, or
approximately 5%. This increase in interest expense was primarily due to
financing costs associated with the private placement of the Company's Series C
Preferred Stock late in 1995.
Liquidity and Capital Resources
Since the DCW Acquisition, the Company's strategy has been to position
itself for growth through new product development and the acquisition of new
technologies through license agreements, joint ventures and purchases of other
companies in the orthopaedic field. As anticipated, the Company's substantial
needs for working capital have been funded through the sale of $85 million of
senior debt securities and $15 million of equity at the time of the DCW
Acquisition, through the issuance of Series B Preferred Stock in 1994 to the
California Public Employees' Retirement System ($60 million),
Page 33 of 119
<PAGE>
through the issuance of Series C Preferred Stock to the Princes Gate purchasers
in September 1995 ($35 million), and through borrowings on the Company's
revolving line of credit.
The Company has available to it a $30 million revolving line of credit
under the Sanwa Agreement (the "Sanwa Agreement") which provided an eligible
borrowing base at December 31, 1997 of $29.1 million. The maximum allowable
borrowing base increased from $25 million to $30 million as a result of the
Exchange Offer. As of December 31, 1997, the Company had drawn $18.5 million
against this line of credit. The Company's strategy and it's interest
obligations to its noteholders have resulted in a continued dependence on the
Sanwa Agreement and other funding sources to meet working capital needs. During
1997, borrowing under the Sanwa Agreement reached $22.6 million compared to the
same period in 1996 when borrowings (under the former Heller Agreement) reached
$16.1 million.
The Company has incurred losses since its inception and anticipates
incurring a loss during 1998. Additionally, the Company's projected working
capital requirements for 1998 indicate a continued reliance on its revolving
credit facility. Accordingly, management continues to closely monitor the
Company's working capital needs and believes the current revolving line of
credit will be sufficient to meet its requirements through 1998.
The Company's capitalization includes senior debt securities of $84.6
million and various series of preferred stock with an aggregate liquidation
value of $152.8 million including accrued but unpaid dividends of $21.3 million
at December 31, 1997. These securities currently bear interest or dividend rates
ranging from 10.0% to 18.88%. The Series D Notes eliminated provisions related
to the Company's obligation to make the sinking fund payments and certain
restrictive covenants of the Old Indenture.
At year-end 1997, the Company had spent approximately $6.0 million in
capital expenditures, and has budgeted expenditures for 1998 of approximately
$4.5 million for the purchase of machinery and related capital equipment.
In assessing the impact of the "Year 2000" on the Company's information
systems, as well as other information system needs, Management has signed a
software license and services agreement with PeopleSoft, Inc. First, management
will upgrade its current system. This will mitigate any year 2000 issues
allowing time for a proper transition to PeopleSoft. Currently, Management
estimates the cost of new information system software to approximate $1.75
million, the majority of which will be incurred in 1999.
Page 34 of 119
<PAGE>
As of December 31, 1997, the Company had net working capital (current
assets less current liabilities) of $40.4 million, compared with $50.5 million
as of December 31, 1996. This $10.1 million decline was attributable to growth
in short term borrowings against the Company's line of credit.
Page 35 of 119
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information called for by this item is set forth in the financial
statements contained in this report on Form 10-K and is incorporated herein by
this reference. An index to the financial statements is set forth on page 61 of
this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
Page 36 of 119
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Executive Officers and Directors
Directors of the Company are elected annually and hold office until the
next annual meeting of stockholders or until their successors are duly elected
and qualified. All officers of the Company are appointed by and serve at the
discretion of the Board of Directors of the Company. Election of directors is
governed in part by a Letter Agreement dated June 30, 1993, as amended on July
29, 1994 and as amended on November 21, 1995 between Mr. Korthoff and Kidd Kamm
Equity Partners, L.P. (the "Letter Agreement"). The following table sets forth
the executive officers and directors of the Company as of March 31, 1998.
Richard H. Mazza and Judy Lindstrom-Foster were executive officers of the
Company during 1997 but are no longer with the Company.
NAME AGE POSITION WITH COMPANY
Thomas M. Patton 34 President and
Chief Executive Officer
Jack E. Parr, Ph.D. 58 Vice Chairman and Chief Scientific
Officer and President Wright
Bio-Orthopaedics Division
Gregory K. Butler 46 Executive Vice President and
Chief Financial Officer
Robert L. Conta 52 Vice President,
Research & Development
Kurt L. Kamm 55 Chairman of the Board of Directors
Richard D. Nikolaev 59 Director
Lewis H. Ferguson, III 53 Director
William J. Kidd 56 Director
Walter S. Hennig 55 Director
Herbert W. Korthoff 54 Director
Stephen R. Munger 40 Director
Richard H. Mazza 51 None Currently
Judy Lindstrom-Foster 53 None Currently
Page 37 of 119
<PAGE>
Thomas M. Patton was appointed President and CEO of the Company in January
1998. Prior to that Mr. Patton was Executive Vice President of Corporate
Development and General Counsel. Along with his legal duties, he also
participated in key strategic company and complimentary product acquisitions for
the Company. Mr. Patton joined the Company in 1993 as General Counsel. He
graduated from Georgetown University and was previously a litigation attorney
for Williams & Connolly in Washington, D.C.
Jack E. Parr, Ph.D. was appointed Vice Chairman and Chief Scientific
Officer of Wright Medical Technology in March 1998 and was also appointed as
President of the Wright Bio-Orthopaedic Division established to concentrate the
Company's resources on its biologics initiatives. Dr. Parr is a world renowned
leader in the field of orthopaedic research. Dr. Parr joined the Company in 1993
with 15 years of experience, which included Vice President of Research for
Zimmer, Inc., a Division of Bristol-Myers Squibb. He is the President-elect of
the Society for Biomaterial and is an active member of the American Standards
for Testing and Materials. Dr. Parr was inducted into the American Academy of
Orthopaedic Surgeons in March 1998 and has been a recipient of many industry
achievement awards, most recently he received a Director's Special Citation from
the FDA's Center for Devices and Radiological Health for his participation in
the American Academy of Orthopaedic Surgeons Forum.
Gregory K. Butler brings 21 years of accounting experience to his position
with 19 years in the orthopaedic industry. He is a graduate of Memphis State
University with a Bachelor's degree in Accounting and a Bachelor's of Science
degree. Mr. Butler joined Dow Corning Wright in 1987 as Manager of Manufacturing
Accounting. He was the acting CFO from July 1992 through July 1993 during the
divestiture of Dow Corning Wright to Wright Medical Technology, Inc. Prior to
joining Dow Corning Wright he was Plant Controller at Richards Medical Company.
Robert L. Conta has been Vice President of Research and Development since
February 1994. Prior to joining the Company and since 1989, Mr. Conta was Vice
President of Engineering and Development for Joint Medical Products Corp., an
orthopaedic joint company. Prior to 1989, Mr. Conta was Vice President of
Research and Development for the Operating Room Division of Baxter Health Care
Corporation. He has a Bachelors degree in Bioengineering from Brown University
and a Masters degree in Mechanical and Aerospace Sciences from the University of
Rochester.
Page 38 of 119
<PAGE>
Kurt L. Kamm has been a Director of the Company since July 1993, serving as
Chairman since August 1997. Mr. Kamm has been an officer and principal
shareholder of Kidd, Kamm & Company, a privately owned investment firm (formerly
a partnership), from 1987 when he co-founded the firm until present. As of
January 1, 1997, Mr. Kamm became an officer, director and co-founder of Kamm
Theodore and is a director of a number of other companies.
Richard D. Nikolaev has been a Director of the Company since July, 1995 and
was the President and Chief Executive Officer of the Company from November 1995
to November 1997. Prior to joining the Company, Mr. Nikolaev served as a
consultant to various medical device companies since December 1994. From January
1992 until December 1994, Mr. Nikolaev was Chairman, President and Chief
Executive Officer of Orthomet, Inc., acquired by the Company in December 1994.
Prior to joining Orthomet, Inc., Mr. Nikolaev served as President of Orthopaedic
Synergy, an orthopaedic consulting company and as an executive officer of
various orthopaedic companies.
Lewis H. Ferguson III has been a Director of the Company since August 1993.
Mr. Ferguson was Senior Vice President and Secretary from January 1994 to
December 1997. Prior to joining the Company, Mr. Ferguson had been a partner in
the Washington, D.C. law firm of Williams & Connolly since 1979. Mr. Ferguson
was on an extended leave of absence from Williams & Connolly but has now
returned to the private practice of law. Mr. Ferguson is elected to serve as a
Director pursuant to the Letter Agreement. Mr. Ferguson is also a director of
OsteoBiologics, Inc., OTT and TEI.
William J. Kidd has been a Director of the Company since July 1993. Mr.
Kidd has been an officer and principal shareholder of Kidd, Kamm & Company, a
privately owned investment firm (formerly a partnership), from 1987 when he
co-founded the firm until present. As of January 1, 1997, Mr. Kidd became an
officer, controlling shareholder and founder of Kidd & Company, LLC and is a
director of a number of other companies.
Walter S. Hennig has been a Director of the Company since April 1994. Mr.
Hennig had been Vice President of Quality Functions at United States Surgical
Corporation since 1976 prior to his retirement in March 1992.
Herbert W. Korthoff has been a Director of the Company since May, 1993,
serving as Chairman from July 1, 1993 to August 1997. Mr. Korthoff served as the
Chief Executive Officer of the Company from July 1993 to November 1995. Prior to
joining the Company, Mr. Korthoff was the Executive Vice President of
Operations, a member of
Page 39 of 119
<PAGE>
the Executive Management Committee and a Director of United States Surgical
Corporation.
Stephen R. Munger is a Managing Director in the Mergers, Acquisition and
Restructuring Department of Morgan Stanley & Co. Incorporated and is Head of the
Private Investment Department. Mr. Munger joined Morgan Stanley in 1988 as a
Vice President in the Corporate Finance Department, became a Principal in 1990,
and a Managing Director in 1993. In 1993 and 1994, Mr. Munger was investment
Banking Division Operations Officer and Administrative Director of the Corporate
Finance Department, respectively. Prior to joining Morgan Stanley, Munger was a
Vice President of the Mergers and Acquisitions Department of Merrill Lynch & Co.
Richard H. Mazza was Vice President of Manufacturing from April 1994 until
March 1996 when he was elected to Executive Vice President of Operations. In
November 1997 he was appointed Chief Operating Officer. Mr. Mazza resigned his
position on January 22, 1998.
Judy Lindstrom-Foster joined Wright Medical Technology, Inc. in September
of 1996 as Vice President of International Sales & Marketing. Prior to joining
the Company, Ms. Lindstrom served as president of Neovision and prior to that as
the president of MicroAire Surgical Instruments, Inc. In September 1997 Ms.
Lindstrom was promoted to Executive Vice President of Global Sales and
Marketing. Ms. Lindstrom resigned her position with the Company in January 1998.
Page 40 of 119
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information with respect to
compensation paid by the Company during the period from January 1, 1995 through
December 31, 1997, to the Company's Chief Operating Officer and to the four most
highly compensated executive officers whose compensation exceeded $100,000 in
1997 (the "Named Executive Officers").
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
Long Term Compensation
----------------------
Annual Compensation Awards
------------------------------------------------------------------------------------------------
(a) (b) (c) (d) (e) (g) (i)
Name and Other Annual Securities Underlying All Other
Principal Position Year Salary Bonus Compensation Options (1) Compensation
- --------------------------- ---- ----------- ------------- ------------ --------------------- --------------------
<S> <C> <C> <C> <C> <C> <C>
Richard D. Nikolaev 1995 $ 51,754(2) - - a. 110,000 common $ 1,891(3)
President and 1996 $525,500 - $ 44,091(4) $ 9,270(5)
Chief Executive Officer 1997 $487,370 - $ 59,428(6) $33,563(7)
Lewis H. Ferguson, III 1995 $525,773 - $ 23,388(8) $ 7,936(9)
Senior Vice President 1996 $525,498 - $ 65,681(10) $ 9,038(11)
1997 $503,622 - $ 79,762(12) $ 7,927(13)
Richard H. Mazza (14) 1995 $150,700 - -(18) a. 10,000 common $21,057(15)
Chief Operating Officer 1996 $173,317 $43,329(16) -(18) a. 30,000 common $ 8,322(17)
1997 $194,067 - -(18) a. 25,000 common $10,038(19)
Jack E. Parr, Ph.D. 1995 $171,783 - -(18) $ 8,458(20)
Vice Chairman and Chief 1996 $176,200 $44,050(16) -(18) $10,122(21)
Scientific Officer and 1997 $183,600 - -(18) a. 25,000 common $ 8,650(22)
President Wright Bio-
Orthopaedics Division
Robert L. Conta 1995 N/A N/A N/A N/A
VP Research & Development 1996 N/A N/A N/A N/A
1997 $164,544 - -(18) a. 15,000 common $ 6,149(23)
Judy Lindstrom-Foster 1995 N/A N/A N/A N/A
Executive Vice President, 1996 N/A N/A N/A N/A
Global Sales & Marketing 1997 $175,000 - -(18) a. 25,000 common $ 6,376(24)
Page 41 of 119
<PAGE>
<FN>
(1) Indicates the number of shares that may be purchased pursuant to
options granted. Options were granted under three separate plans and
are identified as "a" for options to purchase Class A Common Stock
granted pursuant to the 1993 Stock Option Plan; "b" for options to
purchase Class A Common Stock and Series A Preferred Stock granted
pursuant to the 1993 Special Stock Option Plan; "c" for options to
purchase Class A Common Stock granted pursuant to the 1994
Non-Employee Stock Option Plan.
(2) Mr. Nikolaev joined the Company on November 28, 1995 as Chief
Executive Officer and President. His annualized salary in 1995 was
$525,000.
(3) Represents $338 premium for group term life insurance, $1,553 of
401(k) employer matching contributions.
(4) Represents a housing stipend in the amount of $10,186, personal travel
expenses of $14,384, personal use of Company vehicle of $6,536, and
$12,985 to cover expected tax payments on all other annual
compensation.
(5) Represents $664 of club dues, $4,106 of group term life insurance,
and $4,500 of 401(k) employer matching contributions.
(6) Represents a housing stipend of $8,163, personal travel expenses of
$26,187, the use of a Company vehicle valued at $7,189, and $17,889
to cover expected tax payments on all other annual compensation.
(7) Represents $3,763 of group term life insurance, $4,800 of 401(k)
employer matching contributions and $25,000 for consulting services
pursuant to a consulting contract entered into November 1997.
(8) Mr. Ferguson received a housing stipend of $23,388 in 1995.
(9) Includes $844 for club dues, $2,592 for group term life insurance,
and $4,500 of 401(k) employer matching contributions.
(10) Includes a housing stipend of $18,000, personal travel expenses of
$16,202, personal use of a company vehicle of $12,000, and $19,479
to cover expected tax payments on all other annual compensation.
(11) Includes $1,238 for club dues, $672 for the installation of a car
alarm on company vehicle, $2,628 for group term life insurance, and
$4,500 for 401(k) employer matching contributions.
(12) Includes a housing stipend of $25,924, personal travel expenses of
$26,831, personal use of a company vehicle of $11,000, and $16,007 to
cover expected tax payments on all other annual compensation.
(13) Includes $516 for the installation of a home alarm system, $2,611 for
group term life insurance, and $4,800 for 401(k) employer matching
contributions.
(14) Mr. Mazza was appointed Chief Operations Officer in November 1997.
(15) Represents relocation expenses of $16,207, group term life insurance
of $350 and $4,500 of 401(k) employer matching contributions.
(16) Represents 1996 Bonus paid in 1997.
(17) Represents $3,112 of club dues, $710 for group term life insurance,
and $4,500 of 401(k) employer matching contributions.
(18) Other perquisites and personal benefits were less than the lesser of
$50,000 or 10% of the total of annual salary and bonus.
(19) Represents $4,469 of club dues, $769 for group term life insurance,
and $4,800 of 401(k) employer matching contributions.
Page 42 of 119
<PAGE>
(20) Includes $2,556 for club dues, $1,096 for group term life insurance,
$306 for travel, and $4,500 of 401(k) employer matching contributions.
(21) Represents $4,486 of club dues, $1,136 of group term life insurance,
and $4,500 of 401(k) employer matching contributions.
(22) Includes $2,648 for club dues, $1,202 for group term life insurance,
and $4,800 of 401(k) employer matching contributions.
(23) Includes $660 for group term life insurance, $4,800 of 401(k) employer
matching contributions, and $689 of personal travel expenses.
(24) Includes $856 for club dues, $720 for group term life insurance, and
$4,800 of 401(k) employer matching contributions.
</FN>
</TABLE>
Page 43 of 119
<PAGE>
<TABLE>
The following table sets forth certain information with respect to stock
options granted to the Named Executive Officers during 1997.
Option Grants in Last Fiscal Year
<CAPTION>
Potential Realizable Value
at Assumed Annual rates of
Stock Price Appreciation
Individual Grants for Option Term
(a) (b) (c) (d) (e) (f) (g)
Number of % of Total
Securities Options Exercise
Underlying Granted to or Base
Options Employees in Price Expiration
Name Granted (#) Fiscal Year* ($/Sh) Date 5% 10%
<S> <C> <C> <C> <C> <C> <C>
Richard D. Nikolaev 35,000 8.49% $5.00 8/11/07 (2) 110,056.56 278,904.93
Lewis H. Ferguson, III - N/A N/A N/A N/A N/A
Richard H. Mazza 25,000 6.06% $5.00 8/11/07 (1) 78,611.83 199,217.81
Jack E. Parr, Ph.D. 25,000 6.06% $5.00 8/11/07 (1) 78,611.83 199,217.81
Robert L. Conta 15,000 3.64% $5.00 8/11/07 (1) 47,167.10 119,530.68
Judy Lindstrom-Foster 25,000 6.06% $5.00 8/11/07 (1) 78,611.83 199,217.81
<FN>
* 412,215 options were granted in 1997 under the 1993 Management and
Supplemental Management Plans; 85,500 were cancelled.
(1) Options were granted under the Company's 1993 Stock Option Plan. Options
under that Plan entitle holders to purchase shares of Class A Common Stock and
are unconditional on employment. These options become fully vested on July 1,
1998.
(2) Mr. Nikolaev's options vest equally on March 15, 1999 and March 15,
2000 and are subject to a Consulting Agreement.
</FN>
</TABLE>
Page 44 of 119
<PAGE>
<TABLE>
The following table sets forth certain information with respect to
stock options held at December 31, 1997 by the Named Executive Officers.
Aggregated Option Exercises in Last Fiscal Year and FY-End Option Values
<CAPTION>
(a) (b) (c) (d) (e)
Value of Unexercised
In-the-Money(1)
Number of Securities Options at
Shares Underlying Unexercised FY-end ($)
Acquired on Value Options at FY-end (#) Exercisable/
Name Exercise(2) Realized Exercisable/ Unexercisable(3) Unexercisable(3)
<S> <C> <C> <C> <C>
Richard D. Nikolaev (4) - - c. 20,000 / - common - / -
Richard D. Nikolaev (5) - - a. 44,000 /66,000 common - / -
Richard D. Nikolaev (6) - a. - /35,000 common - / -
Lewis H. Ferguson (7) - - a. - /96,500 common - /468,797
Richard H. Mazza (8) - - a. 25,000 / - common 121,450 / -
Richard H. Mazza (5) - - a. 4,000 / 6,000 common - / -
Richard H. Mazza (5) - - a. 12,000 /18,000 common - / -
Richard H. Mazza (6) - - a. - /25,000 common - / -
Jack E. Parr, Ph.D. (8) 17,500 365,015 a. - / - common - / -
Jack E. Parr, Ph.D. (8) - - b. 1,500 / - preferred - / -
Jack E. Parr, Ph.D. (6) - - a. - /25,000 common - / -
Robert L. Conta (8) 17,500 365,015 a. - / - common - / -
Robert L. Conta (8) - - b. 1,500 / - preferred - / -
Robert L. Conta (6) - - a. - /15,000 preferred - / -
Judy Lindstrom-Foster (6) - - a. - /25,000 common - / -
<FN>
(1) Given the lack of a public trading market for the Company's equity securities at December 31, 1997, the fair market value
of the unexercised options for the purpose of this table is $5.00 per share of Class A Common Stock based upon the
Company's internal risk adjusted valuation model. Shares of preferred stock were valued at their cost and, accordingly,
were not in-the-money at December 31, 1997.
(2) Their shares were acquired prior to 8/11/97; the fair market value of these shares at acquisition was $21.00/share.
(3) Options under Plan "a" are granted pursuant to the 1993 Stock Option Plan. Options under Plan "b" are granted pursuant
to the 1993 Special Stock Option Plan. Options under Plan "c" are granted pursuant to the 1994 Non-Employee Stock Option
Plan.
(4) These options are subject to a 4-year vesting schedule and vest in equal parts. The original exercise price for these
options was $13.77; however, it was amended 8/11/97 to $5.00.
(5) These options are subject to a 4-year vesting schedule and vest 20%, 20%, 25%, and 35% in succession. The original exercise
price for these options was $21.00, however, it was amended 8/11/97 to $5.00.
(6) These options vest 7/31/98 and carry an exercise price of $5.00
(7) These options are subject to vesting criteria set forth in the June Letter Agreement and carry an exercise price of $.142.
(8) These options are subject to a 4-year vesting schedule and vest 20%, 20%, 25% and 35% in succession. The exercise
price of these shares is $.142.
</FN>
</TABLE>
Page 45 of 119
<PAGE>
Director Compensation
Directors of the Company are not compensated for their services as
directors with the exception of Mr. Walter Hennig, who receives $1,000 per day
of service as a director and, in consideration of his role as a consultant to
the Company, has been granted options to 5,000 shares of common stock of the
Company. Mr. Hennig's options vest over a four year period at the rate of 20%,
20%, 25% and 35% on the first through fourth anniversary of January 1, 1994. All
non-employee directors of the Company are reimbursed for ordinary and necessary
expenses incurred in attending board or committee meetings.
Employment Contracts
The Letter Agreement provides that the Company's Board of Directors will
consist of seven directors or as otherwise provided under the Company's Restated
Certificate of Incorporation. KKEP has the right to nominate three directors,
Mr. Korthoff has the right to nominate three directors (one of whom is subject
to KKEP's approval) and the holders of the Notes have the right to nominate one
director to the Company's Board.
Board Compensation Committee Interlocks and Insider Participation
The directors functionally acting as the Company's compensation committee
are Mr. Kamm and Mr. Hennig. Also, Mr. Kamm and Mr. Hennig comprise the Option
Committee. Mr. Kamm, Mr. Hennig and Mr. Munger comprise the Audit Committee.
There are no other committees of the Board of Directors.
Page 46 of 119
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following tables set forth, as of December 31, 1997, information with
respect to the beneficial ownership of shares of the Company's Class A Common
Stock and Series A Preferred Stock by (i) each stockholder known by the Company
to be the beneficial owner of more than 5% of either class of such shares, (ii)
each director of the Company, the Company's Chief Executive Officer and each of
the other Named Executive Officers (as defined in Item 11, Executive
Compensation), and (iii) all directors and executive officers of the Company as
a group. Unless otherwise indicated, the persons named in this table have sole
voting power and investment power with respect to all shares beneficially owned
by them.
<TABLE>
<CAPTION>
Amount and Nature of Percentage
Title of Class Name and Address of Beneficial Owners Beneficial Ownership of Class
<S> <C> <C> <C>
Class A Common Stock Kidd Kamm Equity Partners, L.P. 5,353,820 41.34%
Three Pickwick Plaza
Greenwich, Connecticut 06830
Herbert W. Korthoff 1,797,150(1) 13.88%
444 August Drive
Riverton, Wyoming 82501
Barbara Korthoff 1,797,150(2) 13.88%
444 August Drive
Riverton, Wyoming 82501
California Public Employee Retirement System 1,201,224(3) 9.28%
1200 Prospect Street
La Jolla, California 92037
Princes Gate Investors, L.P. 741,110(3) 5.72%
1585 Broadway
New York, New York 10036
Williams J. Kidd 5,353,820(4) 41.34%
c/o Kidd, Kamm & Company
Three Pickwick Plaza
Greenwich, Connecticut 06830
Kurt L. Kamm 5,353,820(4) 41.34%
c/o Kidd, Kamm & Company
9454 Wilshire Boulevard, Suite 920
Beverly Hills, California 90212
Richard D. Nikolaev 64,000(5) 0.49%(7)
Lewis H. Ferguson, III 479,920(6) 3.71%
Jack E. Parr, Ph.D. 65,000 0.50%(7)
Robert L. Conta 65,000 0.50%(7)
Richard H. Mazza 41,000 0.32%(7)
Walter S. Hennig 5,000 0.04%(7)
Judy Lindstrom-Foster - 0.00%(7)
All directors and officers as a group (11 persons) 7,870,890 60.78%
Page 47 of 119
<PAGE>
<FN>
(1) Includes 96,500 shares of Class A Common Stock held by Mr. Korthoff's wife, Barbara Korthoff, of which Mr. Korthoff
disclaims beneficial ownership.
(2) Includes 1,700,650 shares of Class A Common Stock held by Mrs. Korthoff's husband, Herbert Korthoff, of which Mrs. Korthoff
disclaims beneficial ownership.
(3) Shares subject to warrants currently exercisable.
(4) Deemed to be the beneficial owners of the Class A Common Stock beneficially owned by KKEP, since Mr. Kidd and Mr. Kamm
control KKEP.
(5) Represents shares subject to options that are exercisable currently.
(6) Includes 96,500 shares subject to repurchase by KKEP under certain conditions pursuant to the Letter Agreement, and
includes 96,500 shares of Class A Common Stock issuable pursuant to options granted to Mr. Ferguson, which options may
be exercisable within the next 60 days as determined by formula contained in the Letter Agreement.
(7) Less than one percent (1%).
</FN>
</TABLE>
Page 48 of 119
<PAGE>
<TABLE>
<CAPTION>
Amount and Nature of Percentage
Title of Class Name and Address of 5% Beneficial Owner Beneficial Ownership of Class
<S> <C> <C> <C>
Series A Preferred Stock Kidd Kamm Equity Partners, L.P. 535,382 63.49%
Three Pickwick Plaza
Greenwich, Connecticut 06830
Herbert W. Korthoff 179,715(1) 21.31%
444 August Drive
Riverton, Wyoming 82501
Barbara W. Korthoff 179,715(2) 21.31%
444 Augusta Drive
Riverton, Wyoming 82501
William J. Kidd 535,382(3) 63.49%
c/o Kidd, Kamm & Company
Three Pickwick Plaza
Greenwich, Connecticut 06830
Kurt L. Kamm 535,382(3) 63.49%
c/o Kidd, Kamm & Company
9454 Wilshire Boulevard; Suite 920
Beverly Hills, California 90212
Richard D. Nikolaev - -
Lewis H. Ferguson, III 38,342(4) 4.55%
Robert L. Conta 1,500(5) .18%(6)
Jack E. Parr, Ph.D. 1,500(5) .18%(6)
Richard H. Mazza - -
Walter S. Hennig - -
Judy Lindstom-Foster - -
All directors and officers as a group (11 persons) 756,439 89.70%
<FN>
(1) Includes 9,650 shares of Series A Preferred Stock held by Mr. Korthoff's wife Barbara Korthoff, of which Mr. Korthoff
disclaims beneficial ownership.
(2) Includes 170,065 shares of Series A Preferred Stock held by Mrs. Korthoff's husband, Herbert Korthoff, of which Mrs.
Korthoff disclaims beneficial ownership.
(3) Deemed to be the beneficial owners of the Series A Preferred Stock beneficially owned by KKEP, since Mr. Kidd and Mr. Kamm
control KKEP.
(4) Includes 9,650 shares subject to repurchase by KKEP under certain conditions pursuant to the Letter Agreement.
(5) Represents shares subject to options which are currently exercisable.
(6) Less than one percent (1%).
</FN>
</TABLE>
Page 49 of 119
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Management Agreement with Kidd Kamm & Company and its Affiliates
Kidd Kamm & Company, an affiliate of KKEP, has a management services
agreement with the Company pursuant to which it renders management, consulting
and related services to the Company for an annual management fee of $360,000
(modified to $260,000 as of August 1, 1997), subject to increases as determined
by the Board of Directors of the Company, plus out-of-pocket expenses.
Tissue Engineering, Inc.
In February 1997, William J. Kidd and the other principals of Kidd and
Company, LLC purchased common stock and warrants to acquire additional common
stock options in TEI (a company with which the Company entered into a joint
venture agreement in 1996). Kidd and Company, LLC is providing financial
advisory services to TEI.
Transactions with Investors
Stock Transactions. At the Acquisition closing date, Herbert W. Korthoff,
the Company's Chairman, purchased 1,254,500 shares of Class A Common Stock and
125,450 shares of Series A Preferred Stock plus 96,500 shares of Class A Common
Stock and 9,650 shares of Series A Preferred Stock purchased in his wife's name,
by delivering to the Company two recourse promissory notes in his name, the H.
Korthoff Group 1 Note in the principal amount of $1,232,877 with respect to the
purchase of the H. Korthoff Group 1 Shares, consisting of 579,000 shares of
Class A Common Stock and 57,900 shares of Series A Preferred Stock, and the H.
Korthoff Group 2 Note in the principal amount of $1,438,356 with respect to the
purchase of the H. Korthoff Group 2 Shares, consisting of 675,500 shares of
Class A Common Stock and 67,550 shares of Series A Preferred Stock and by
delivering to the Company two promissory notes in his wife's name, the Mrs.
Korthoff Group 1 Note in the principal amount of $102,739 with respect to the
purchase of the Mrs. Korthoff Group 1 Shares, consisting of 48,250 shares of
Class A Common Stock and 4,825 shares of Series A Preferred Stock, and the Mrs.
Korthoff Group 2 Note in the principal amount of $102,739 with respect to the
purchase of the Mrs. Korthoff Group 2 Shares, consisting of 48,250 shares of
Class A Common Stock and 4,825 shares of Series A Preferred Stock.
On June 1, 1994, the Company requested that the holders of the Notes waive
certain provisions of the Indenture to allow the Company to repurchase from Mr.
Korthoff 798,380 shares of Class A Common Stock
Page 50 of 119
<PAGE>
and 79,838 shares of Series A Preferred Stock for use in employee incentive
programs. The Company was notified on July 22, 1994 of the approval of the
holders of the Notes for such a transaction and accordingly repurchased such
shares for $1,700,549 through a pro rata credit of that sum against the
principal balance of the H. Korthoff Group 1 Note and the H. Korthoff Group 2
Note. On December 27, 1995, Herbert W. Korthoff and Barbara Korthoff paid the
Company $1,176,162 representing the entire principal of the Korthoff Group 1
Note and Korthoff Group 2 Notes. The balance of the Group 1 Notes and Group 2
Notes, representing the accrued but unpaid interest on such notes, is evidenced
by the Amended Note.
Lewis H. Ferguson III, a director and officer of the Company, purchased at
the Acquisition closing date 289,500 shares of Class A Common Stock and 28,950
shares of Series A Preferred Stock by delivering to the Company two recourse
promissory notes, the Ferguson Group 1 Note in the principal amount of $410,959
with respect to the purchase of the Ferguson Group 1 Shares consisting of
193,000 shares of Class A Common Stock and 19,300 shares of Series A Preferred
Stock and the Ferguson Group 2 Note (together with the Ferguson Group 1 Note,
the "Ferguson Notes") in the principal amount of $205,480 with respect to the
purchase of the Ferguson Group 2 Shares consisting of 96,500 shares of Class A
Common Stock and 9,650 shares of Series A Preferred Stock.
The Amended Note is full recourse and (i) will mature on June 30, 1998,
subject to acceleration upon a sale of all or substantially all of the business,
assets or issued and outstanding capital stock of the Company or the successful
completion of an initial public offering by the Company of any of its equity
securities pursuant to the Securities Act, and (ii) is secured by a pledge of,
and the Company is entitled to offset, all dividends payable on the Series A
Preferred Stock held by Herbert W. Korthoff and Barbara Korthoff. The Ferguson
Notes are full recourse and (i) bear interest, payable semi-annually (but which
interest may be, and to date has been, deferred and added to principal at the
option of the maker), at the rate of 10% per annum, (ii) will mature on June 30,
1998, subject to acceleration upon a sale of all or substantially all of the
business, assets or issued and outstanding capital stock of the Company or the
successful completion of an initial public offering by the Company of any of its
equity securities pursuant to a registration statement under the Securities Act,
and (iii) are secured by the pledge of the Ferguson Group 1 and Ferguson Group 2
Shares to the Company.
Pursuant to the Letter Agreement among KKEP, the Company and each of Mr.
Korthoff, his wife and Mr. Ferguson, each dated June 30, 1993, upon the
occurrence of an Event of Default (defined as including (a)
Page 51 of 119
<PAGE>
any default in the payment of principal or interest which has continued for ten
(10) business days, or (b) certain bankruptcy, insolvency or similar proceedings
not dismissed, vacated or stayed within sixty (60) days) under the Ferguson
Notes, the Company has the right to foreclose upon the Ferguson Shares, and KKEP
has the right to elect to succeed to all the rights of the Company under said
Ferguson Notes and related stock pledge agreements. In the event KKEP elects to
succeed to all rights of the Company under said Ferguson Notes, KKEP must make
full payment to the Company of the outstanding balance of the Ferguson Notes, as
the case may be, and allow each of the other initial cash equity investors in
the Company (except the defaulting noteholder) to participate in such purchase
in proportion to their respective ownership of the capital stock of the Company.
Mr. Ferguson also owns 9,650 shares of Series A Preferred Stock and 96,500
shares of Class A Common Stock of the Company which are subject to repurchase by
KKEP or the Company in the event that KKEP has not achieved a certain target
rate of return on its equity investment in the Company in accordance with a
formula that is set forth in an attachment to the Letter Agreement. In addition,
Mr. Ferguson holds options to purchase 96,500 shares of the Company's Class A
Common Stock that vest only in the event that KKEP achieves the target rates of
return described in the attachment to the Letter Agreement.
Payments to Outside Counsel. Mr. Ferguson is a partner (on an extended
leave of absence) in the law firm of Williams & Connolly, which the Company
retained during fiscal years 1994, 1995, 1996 and 1997.
Officer and Director Arrangements. The Letter Agreement provides that the
Company's Board of Directors will consist of seven directors or as otherwise
provided under the Company's Restated Certificate of Incorporation. KKEP has the
right to nominate three directors, Mr. Korthoff has the right to nominate three
directors (one of which is subject to KKEP's approval) and the holders of the
Notes have the right to nominate one director to the Company's Board. Messrs.
Kidd, Kamm and Nikolaev are KKEP's nominees and Messrs. Korthoff, Ferguson, and
Hennig are Mr. Korthoff's nominees. Steve Munger was elected by the
stockholders. Neither KKEP nor the noteholders has nominated any other directors
as of the date hereof.
Principal Stockholders' Agreement. Pursuant to the terms of the Principal
Stockholders' Agreement, except for certain permitted transfers including the
repurchase by KKEP and such of the other parties to the agreement of a
defaulting person's shares subject to pledge to the Company, no person subject
thereto may sell any of his,
Page 52 of 119
<PAGE>
her or its shares of capital stock of the Company.
The Principal Stockholders' Agreement also provides that if, at any time
prior to the third anniversary of the Principal Stockholders' Agreement and
provided no Event of Default (as defined in the Indenture) has occurred and is
continuing under the terms of the Indenture, the holders of more than 662/3% of
the issued and outstanding shares (the "Requisite Percentage") determine to sell
all of their shares in an arm's-length transaction to an unaffiliated third
person, then all holders will sell all of their shares under the terms of the
sale, subject to certain conditions, but not to any restrictions as to price. At
any time after the third anniversary of the Principal Stockholders' Agreement,
or at any time an Event of Default under the terms of the Indenture has occurred
and is continuing at the time a contract of sale is entered into, the Requisite
Percentage necessary to cause the other stockholders to sell their shares in a
qualified transaction will be a majority-in-interest of the issued and
outstanding shares of capital stock.
The Principal Stockholders' Agreement also grants holders tag- along rights
making any transfers subject to the right of other holders to participate in
such transfer in proportion to their ownership of shares of the Company's
capital stock at the same price per share being offered to the transferring
holder. The Principal Stockholders' Agreement terminates on the closing of an
underwritten public offering of the Company's shares of Common and Preferred
Stock pursuant to a registration statement under the Securities Act declared
effective by the Securities and Exchange Commission.
Other Related Party Transactions. In 1995, Mr. Nikolaev was paid a
consulting fee of $135,000 for consulting services performed for the Company.
Also, in 1997, a consulting fee of $25,000 was paid to Mr. Nikolaev for
consulting services. At the election of Mr. Nikolaev, such amounts were paid to
the company through which the services were rendered and which is owned by one
of the members of his family.
On June 30, 1994 Mr. Ferguson received a loan from the Company in the
amount of $75,000 for the purchase of a residence. That loan bears interest at
7.25%, the prime rate as of June 30, 1994. The original note was due January 1,
1996 and then extended and was secured by Mr. Ferguson's stock in the Company.
On December 19, 1997 the Company purchased the home of Mr. Ferguson for $423,000
and sold it for $341,000 in an auction on December 21, 1997. The note was
effectively repaid as a result of this transaction.
Page 53 of 119
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
8-K.
(a) The following documents are filed or incorporated by
reference as part of this Form 10-K:
1. Financial Statements and Financial Statement
Schedules:
The "Index to Financial Statements" set forth on page
61 of this Form 10-K is incorporated herein by
reference.
Schedules have been omitted because either they are
not required or the information is included elsewhere
in the financial statements and notes thereto.
2. Exhibits (Exhibits listed below without parenthesis
are filed herewith.)
EXHIBIT DESCRIPTION OF EXHIBIT
2.1 (1) Purchase and Sale Agreement, dated May
14, 1993, among the Company, Dow
Corning and Dow Corning Wright
Corporation.
3.1 (6) Restated Certificate of Incorporation
of the Company dated September 25,
1995.
3.2 (1) By-Laws of the Company.
4.1 (1) Indenture dated as of June 30, 1993,
between the Company and the First
National Bank of Boston, as trustee.
4.1a (1) First Supplemental Indenture, dated as
of November 1, 1993, between the
Company and The First National Bank of
Boston.
Page 54 of 119
<PAGE>
4.2 (1) Security Agreement dated as of June 30,
1993, between the Company and
BancBoston Trust Company of New York,
as collateral agent acting on behalf of
the First National Bank of Boston.
4.3 (1) Pledge Agreement, dated as of June 30,
1993, between the Company and
BancBoston Trust Company of New York,
as collateral agent acting on behalf of
The First National Bank of Boston.
4.4 (1) Form of Purchase Agreement, dated June
30, 1993, between the Company and the
purchasers of the Notes.
4.5 (1) Registration Rights Agreement, dated as
of June 30, 1993, between the Company
and the purchasers of the Notes.
4.6 (5) Series B Preferred Stock Purchase and
Class A Common Stock Warrant Agreement,
dated July 29, 1994, between the
Company and CalPERS.
4.6a (7) Amendment No. 1 dated September 25,
1995 to Series B Preferred Stock
Purchase and Class A Common Stock
Warrant Agreement, dated July 29, 1994
between the Company and CalPERS.
4.7 (10) Indenture dated as of August 7, 1997
between the Company and State Street
Bank and Trust Company, as Trustee.
4.8 (10) Form of Note for the Company's Series D
11 3/4% Senior Secured Step-up Note.
4.9 (10) Registration Rights Agreement dated as
of August 7, 1997 between the Company
and Holders of the Registrant's Series
C 11 3/4% Senior Secured Step-up Notes.
10.1 (1) Product Manufacturing Agreement, dated
June 30, 1993, between the Company and
Dow Corning Corporation.
10.2 (1) Revolving Credit Agreement, dated
September 30, 1993, between the Company
and Heller Financial, Inc.
Page 55 of 119
<PAGE>
10.3 (1) Principal Stockholders' Agreement,
dated June 30, 1993, among the Company
and certain of its stockholders.
10.4 (1) Omnibus Stockholders' Agreement, among
the Company and certain of its
stockholders.
10.5 (1) License Agreement, dated June 25, 1993,
between the Company and Dr. Alfred B.
Swanson.
10.6 (4) 1993 Stock Option Plan
10.7 (4) 1993 Special Stock Option Plan
10.8 (4) Employee Common Stock Grant Plan
10.9 (4) Distributor Stock Purchase Plan
10.10 (1) Industrial Development Lease Agreement
date as of July 9, 1985 between The
Industrial Development Board of The
City of Arlington, Tennessee (the
"Arlington IDB") and Dow Corning
Wright, Inc.
10.11 (1) Lease and Security Agreement dated as
of April 1, 1974 between the Arlington
IDB and Wright Manufacturing Company
together with First Supplement to Lease
dated as of December 1, 1981.
10.12 (1) Industrial Development Lease Agreement
dated as of June 29, 1984 between
Langston Associates and the Arlington
IDB.
10.13 (1) Letter Agreements dated June 30, 1993
among the Company and certain of its
Stockholders with Promissory Notes and
Stock Pledge and Security Agreements
attached.
10.14 (3) Letter Agreement dated June 30, 1993
between KKEP and Herbert W. Korthoff,
Lewis Ferguson, and Barbara Korthoff.
Page 56 of 119
<PAGE>
10.14a (5) Amendment dated July 29, 1994 to Letter
Agreement dated June 30, 1993 between
KKEP and Herbert W. Korthoff, Lewis
Ferguson, and Barbara Korthoff.
10.15 (1) Agreement dated January 24, 1983,
between Leo A. Whiteside, M.D. and the
Company.
10.16 (2) Acquisition Agreement dated February 5,
1994, between the Company and
OrthoTechnique.
10.17 (5) Distribution Agreement dated December
20, 1993, between the Company and
Kaneka Medix Corporation.
10.18 (5) Research and Development Agreement
dated October 7, 1994, between the
Company and OsteoBiologics, Inc.
10.19 (3) Acquisition Agreement dated December 8,
1994, between the Company and Orthomet.
10.20 (5) 1994 Distributor Stock Option Plan.
10.21 (5) Non-qualified Stock Option Agreement
for Non-Employees.
10.22 (7) Securityholders Agreement, dated
September 25, 1995, between the
Company, the purchasers named therein
and PG Investors, Inc., as agent.
Distribution Agreement dated February
22, 1996, between the Company and
Century Medical, Inc.
10.24 (8) Revolving Credit Agreement, dated
September 13, 1996 between the Company
and Sanwa Business Credit Corporation.
10.25 (9) Joint Venture Agreement, dated July 12,
1996 between the Company and Tissue
Engineering, Inc.
10.26 Amended and Restated Joint Venture
Agreement, dated August 1997 between
the Company and Tissue Engineering,
Inc.
Page 57 of 119
<PAGE>
11.1 Statement re: Computation of earnings
per share.
12.1 Statement re: Computation of ratios of
earnings to fixed charges and preferred
dividends.
21.1 Subsidiaries of the Company.
23.2 Consent of Arthur Andersen LLP
(1) Document incorporated by reference from
Registration Statement on Form S-4 No.
33-69286 filed by the Company on
November 10, 1993.
(2) Document incorporated by reference to
Current Report on Form 8-K dated as of
February 5, 1994.
(3) Document incorporated by reference to
Current Report on Form 8-K dates as of
December 8, 1994.
(4) Document incorporated by reference to
Annual Report on Form 10-K filed March
25, 1994.
(5) Document incorporated by reference to
Annual Report on Form 10-K filed March
31, 1995.
(6) Document incorporated by reference to
Quarterly Report on Form 10-Q filed
November 14, 1995.
(7) Document incorporated by reference to
Annual Report on Form 10-K filed March
31, 1996.
(8) Document incorporated by reference to
current report on Form 8-K dated as of
September 13, 1996.
(9) Document incorporated by reference to
Annual Report on Form 10-K filed March
31, 1997.
Page 58 of 119
<PAGE>
(10) Document incorporated by reference from
Registration Statement on Form S-4 No.
333-34853 filed by the Company on
November 3, 1997.
(b) Reports on Form 8-K
None
Page 59 of 119
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
WRIGHT MEDICAL TECHNOLOGY, INC. (Registrant)
BY: /s/Thomas M. Patton
Thomas M. Patton
President and Chief Executive Officer
DATE: March 30, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE (CAPACITY) DATE
President, Chief Executive
/s/Thomas M. Patton Officer, and Director
Thomas M. Patton (Principal Executive Officer) March 30, 1998
Executive Vice President and
/s/Greg K. Butler Chief Financial Officer
Greg K. Butler (Principal Financial Officer) March 30, 1998
/s/Joyce B. Jones
Joyce B. Jones Vice President, Controller March 30, 1998
/s/Kurt L. Kamm Chairman of the Board of
Kurt L. Kamm Directors March 30, 1998
/s/Lewis H. Ferguson,III
Lewis H. Ferguson, III Director March 30, 1998
/s/William J. Kidd
William J. Kidd Director March 30, 1998
/s/Herbert W. Korthoff
Herbert W. Korthoff Director March 30, 1998
/s/Walter S. Hennig
Walter S. Hennig Director March 30, 1998
/s/Richard D. Nikolaev
Richard D. Nikolaev Director March 30, 1998
/s/Stephen R. Munger
Stephen R. Munger Director March 30, 1998
Page 60 of 119
<PAGE>
INDEX TO FINANCIAL STATEMENTS
Wright Medical Technology, Inc.
Report of Independent Public Accountants.................................62
Consolidated Financial Statements:
Consolidated Balance Sheets as of
December 31, 1997 and 1996 .......................................63
Consolidated Statements of Operations for
the Year Ended December 31, 1997, 1996 and 1995...................64
Consolidated Statements of Cash Flows for
the Year Ended December 31, 1997, 1996 and 1995...................65
Consolidated Statements of Changes in Stockholders'
Investment for the Year Ended December 31, 1997, 1996
and 1995..........................................................66
Notes to Consolidated Financial Statements..........................67
Page 61 of 119
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of Wright Medical Technology, Inc.:
We have audited the accompanying consolidated balance sheets of Wright
Medical Technology, Inc. (a Delaware corporation) and subsidiaries as of
December 31, 1997 and 1996, and the related consolidated statements of
operations, changes in stockholders' investment and cash flows for the years
ended December 31, 1997, 1996 and 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Wright Medical Technology,
Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for the years ended December 31, 1997, 1996 and
1995, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Memphis, Tennessee,
March 25, 1998.
Page 62 of 119
<PAGE>
<TABLE>
WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<CAPTION>
December 31, December 31,
1997 1996
------------ ------------
(in thousands) (in thousands)
ASSETS
Current Assets:
<S> <C> <C>
Cash and cash equivalents $ 466 $ 910
Trade receivables, net 19,040 18,289
Inventories, net 58,890 59,107
Prepaid expenses 1,716 1,692
Deferred income taxes 143 978
Other 1,890 2,540
------------ ------------
Total Current Assets 82,145 83,516
------------ ------------
Property, Plant and Equipment, net 26,732 33,659
Investment in Joint Venture 2,380 3,597
Other Assets 41,826 45,554
------------ ------------
$ 153,083 $ 166,326
============ ============
LIABILITIES AND STOCKHOLDERS' INVESTMENT
Current Liabilities:
Current portion of long-term debt $ 322 $ 138
Short-term borrowing 18,500 8,390
Accounts payable 6,212 6,063
Accrued expenses and other current liabilities 16,745 18,453
------------ ------------
Total Current Liabilities 41,779 33,044
------------ ------------
Long-Term Debt 85,104 84,668
Preferred Stock Dividends 21,309 17,999
Other Liabilities 1,805 3,189
Deferred Income Taxes 143 978
------------ ------------
Total Liabilities 150,140 139,878
------------ ------------
Commitments and Contingencies
Mandatorily Redeemable Series B Preferred Stock, $.01 par value, (aggregate
liquidation value of $83.0 million, including accrued and unpaid dividends of
$3.0 million, 800,000 shares authorized, 800,000 and 711,910 shares
issued and outstanding) 70,511 59,959
Redeemable Convertible Series C Preferred Stock, $.01 par value, (aggregate
liquidation value of $44.5 million, including accrued and unpaid dividends of
$9.5 million, 350,000 shares authorized, issued and outstanding) 29,442 24,995
Stockholders' Investment:
Series A preferred stock, $.01 par value, (aggregate liquidation value of
$25.2 million, including accrued and unpaid dividends of $8.7 million),
1,200,000 shares authorized, 915,325 shares issued 9 9
Undesignated preferred stock, $.01 par value, 650,000 shares authorized,
no shares issued - -
Class A common stock, $.001 par value, 46,000,000 shares authorized,
10,585,000 and 10,023,421 shares issued 11 10
Class B common stock, $.01 par value, 1,000,000 shares authorized,
no shares issued - -
Additional capital 57,545 53,853
Accumulated deficit (153,025) (111,855)
Other (509) 516
------------ ------------
(95,969) (57,467)
Less - Notes receivable from stockholders (1,039) (1,037)
Series A preferred treasury stock, 86,688 shares (1) (1)
Class A common treasury stock, 887,130 shares (1) (1)
------------ ------------
Total Stockholders' Investment (97,010) (58,506)
------------ ------------
$ 153,083 $ 166,326
============ ============
The accompanying notes are an integral part of these consolidated balance sheets.
Page 63 of 119
</TABLE>
<PAGE>
<TABLE>
WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except earnings per share)
<CAPTION>
Year Ended December 31,
------------------------------------------------------
1997 1996 1995
---------------- ---------------- ----------------
<S> <C> <C> <C>
Net sales $ 122,397 $ 121,868 $ 123,196
Cost of goods sold 46,687 44,433 33,722
---------------- ---------------- ----------------
Gross profit 75,710 77,435 89,474
---------------- ---------------- ----------------
Operating expenses:
Selling 50,988 47,437 47,085
General and administrative 20,129 19,357 23,358
Research and development 11,609 13,196 12,728
Equity in loss of joint venture 1,217 500 -
---------------- ---------------- ----------------
83,943 80,490 83,171
---------------- ---------------- ----------------
Operating income (loss) (8,233) (3,055) 6,303
Interest, net 13,062 11,947 11,322
Other (income) expense, net 1,277 (413) (146)
---------------- ---------------- ----------------
Loss before income taxes (22,572) (14,589) (4,873)
Income tax provision - - 1,619
---------------- ---------------- ----------------
Net loss $ (22,572) $ (14,589) $ (6,492)
================ ================ ================
Loss applicable to common stock $ (41,170) $ (35,298) $ (19,783)
================ ================ ================
Basic loss per share of common stock $ (4.38) $ (3.90) $ (2.24)
================ ================ ================
Basic weighted average common shares outstanding 9,397 9,059 8,825
================ ================ ================
The accompanying notes are an integral part of these statements.
Page 64 of 119
</TABLE>
<PAGE>
<TABLE>
WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<CAPTION>
Year Ended December 31,
------------------------------------------------
1997 1996 1995
-------------- -------------- --------------
Cash Flows From Operating Activities:
<S> <C> <C> <C>
Net loss $ (22,572) $ (14,589) $ (6,492)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation 6,879 7,007 7,272
Instrument amortization 6,047 4,265 4,337
Provision for instrument reserves 3,565 3,647 -
Provision for excess/obsolete inventory 4,231 (453) (2,369)
Provision for sales returns 59 (247) 290
Deferred income tax provision - - 1,270
Deferred income - 1,502 -
Amortization of intangible assets 3,364 3,266 3,747
Amortization of deferred financing costs 1,387 1,361 1,036
Loss on disposal of equipment 95 485 97
Equity in loss of joint venture 1,217 500 -
Other 1,928 614 (178)
Changes in assets and liabilities, net of effect of
purchases of businesses
(Increase) decrease in accounts receivables (861) 442 (522)
Increase in inventories (7,792) (3,335) (18,101)
(Increase) decrease in other current assets 626 (1,104) (77)
Increase (decrease) in accounts payable 149 (1,706) 2,741
Increase (decrease) in accrued expenses and other liabilities 822 (1,380) (16,848)
Increase in other assets (683) (840) (1,869)
-------------- -------------- --------------
Net cash used in operating activities (1,539) (565) (25,666)
-------------- -------------- --------------
Cash Flows From Investing Activities:
Capital expenditures (6,015) (3,778) (12,525)
Proceeds from Sale-Leaseback Transactions 607 - -
Other (120) (884) (1,139)
-------------- -------------- --------------
Net cash used in investing activities (5,528) (4,662) (13,664)
-------------- -------------- --------------
Cash Flows From Financing Activities:
Net proceeds from short-term borrowings 10,110 4,490 3,900
Proceeds from issuance of stock and stock warrants - 1,278 33,409
Payments of debt issuance costs (56) (387) -
Payments of debt (3,431) (446) (641)
Proceeds from stockholders on notes receivable - - 1,225
Other - 76 (509)
-------------- -------------- --------------
Net cash provided by financing activities 6,623 5,011 37,384
-------------- -------------- --------------
Net decrease in cash and cash equivalents (444) (216) (1,946)
Cash and cash equivalents, beginning of period 910 1,126 3,072
-------------- -------------- --------------
Cash and cash equivalents, end of period $ 466 $ 910 $ 1,126
============== ============== ==============
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ 11,020 $ 10,474 $ 11,885
============== ============== ==============
Cash paid for income taxes $ 22 $ 33 $ 234
============== ============== ==============
The accompanying notes are an integral part of these statements.
Page 65 of 119
</TABLE>
<PAGE>
<TABLE>
WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' INVESTMENT
(in thousands)
<CAPTION>
Number of Shares Notes
Series A Class A Series A Class A Receivable
Preferred Common Preferred Common Additional Accumulated From Treasury
Stock Stock Stock Stock Capital Deficit Other Stockholders Stock Total
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, 12/31/94 916 9,441 $9 $9 $ 32,786 $ (56,774) $ 439 $(1,969) $(2) $(25,502)
Issuance of common stock - 350 - 1 497 - - - - 498
Issuance of common stock
warrants - - - - 18,187 - - - - 18,187
Preferred stock dividend - - - - - (10,455) - - - (10,455)
Payments on stockholder
notes receivable - - - - - - - 1,225 - 1,225
Accretion of preferred
stock discount - - - - - (2,836) - - - (2,836)
Net loss - - - - - (6,492) - - - (6,492)
Other (1) - - - - - 491 (293) - 198
--------------------------------------------------------------------------------------------------------
BALANCE, 12/31/95 915 9,791 9 10 51,470 (76,557) 930 (1,037) (2) (25,177)
Issuance of common stock - 232 - - 2,383 - - - - 2,383
Preferred stock dividend - - - - - (14,251) - - - (14,251)
Accretion of preferred
stock discount - - - - - (6,458) - - - (6,458)
Net loss - - - - - (14,589) - - - (14,589)
Other - - - - - - (414) - - (414)
--------------------------------------------------------------------------------------------------------
BALANCE, 12/31/96 915 10,023 9 10 53,853 (111,855) 516 (1,037) (2) (58,506)
Issuance of common stock
warrants - - - - 287 - - - - 287
Issuance of common stock - 562 - 1 3,405 - - - - 3,406
Preferred stock dividend - - - - - (12,121) - - - (12,121)
Accretion of preferred
stock discount - - - - - (6,477) - - - (6,477)
Net loss - - - - - (22,572) - - - (22,572)
Other - - - - - - (1,025) (2) - (1,027)
--------------------------------------------------------------------------------------------------------
BALANCE, 12/31/97 915 10,585 $9 $11 $ 57,545 $(153,025) $(509) $(1,039) $(2) $(97,010)
========================================================================================================
The accompanying notes are an integral part of these statements.
Page 66 of 119
</TABLE>
<PAGE>
WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Description of Business -
Wright Medical Technology, Inc. and its subsidiaries (the "Company") engage
in the business of developing, manufacturing and selling orthopaedic products,
principally knee and hip implants. The Company's products are designed to
restore mobility and relieve pain through the replacement of damaged or diseased
joints. The Company distributes its products through various distributors with
approximately 73% of its products sold in the United States. The Company
purchased substantially all of the assets of Dow Corning Wright Corporation
("DCW") on June 30, 1993 (the "DCW Acquisition").
Liquidity and Capital Resources -
Since the DCW Acquisition, the Company's strategy has been to position
itself for aggressive growth through new product development and the acquisition
of new technologies through license agreements, joint venture arrangements and
the purchase of other companies in the orthopaedic industry (see Note 2). The
Company has funded this strategy through the sale of $85 million of senior debt
securities and the contribution of approximately $15 million of equity at the
time of the DCW Acquisition. Further, the Company has obtained additional
capital through the issuance of $60,000,000 of Series B Preferred Stock in 1994
and $35,000,000 of Series C Preferred Stock in 1995 (see Note 8). The Company
has also funded its growth and working capital requirements through the use of
revolving lines of credit (see Note 7).
The Company has incurred significant losses since its inception and
anticipates incurring a loss during 1998. Additionally, the Company's projected
working capital requirements for 1998 indicate a continued reliance on its
revolving credit facility. The Company has available to it a $30 million
revolving line of credit under the Sanwa Agreement. Accordingly, management
continues to closely monitor the Company's working capital needs and believes
the current revolving line of credit will be sufficient to meet its working
capital requirements through 1998.
Page 67 of 119
<PAGE>
During August 1997, the Company completed an exchange of its 10 3/4% Series
B Senior Secured Notes for the 11 3/4% Series C Senior Secured Step-Up Notes.
(See Note 7).
Significant Risks and Uncertainties -
Inherent in the accompanying financial statements are certain risks and
uncertainties which include, but are not limited to, the following:
Significant Leverage
The Company is, and will continue to be, highly leveraged. The Company has
incurred substantial indebtedness as a result of its acquisitions, new product
research and development and operating losses. Earnings were inadequate to cover
fixed charges, preferred dividends and accretion of preferred stock by
approximately $41.2 million for the year ended December 31, 1997. The Company's
high level of debt may have several important affects on its future operations,
including the following: (i) a substantial portion of the Company's cash flow
from operations must be dedicated to the payment of interest on its
indebtedness; (ii) the financial covenants contained in its debt facilities will
require the Company to meet certain financial tests and other restrictions which
limit its ability to borrow additional funds or to dispose of assets; and (iii)
the Company's ability to obtain additional financing in the future for working
capital, capital expenditures, acquisitions, general corporate purposes or other
purposes may be impaired. In addition, the Company's ability to meet its debt
service obligations and to reduce its total debt will be dependent upon the
Company's future performance, which will be subject to general economic
conditions and to financial, business and other factors affecting the operations
of the Company, many of which are beyond its control. There can be no assurance
that the Company's future performance will not be adversely affected by such
economic conditions and financial, business and other factors.
Ability to Develop, Manufacture and Market New Products
Some of the Company's products are currently under development or have not
yet been approved by the Food and Drug Administration ("FDA") (or other
applicable foreign regulatory bodies). Although management believes these
products will be successfully developed, that the necessary FDA or foreign
approvals will be received and, if developed and approved, a market for these
products will exist; there can be no assurance that such events will happen. In
order for the Company to
Page 68 of 119
<PAGE>
remain competitive and to retain market share, it must continually develop new
products as well as improve its existing ones. Accordingly, the Company must
devote substantial resources to research and development. Although the Company
intends to devote such resources, there can be no assurance that the Company
will be able to enhance its existing products, introduce or acquire new
products, and maintain or expand its market share.
Patent Protection and Related Litigation
Management considers certain of its patents to be significant to its
business. In the medical device industry, patent litigation among competitors
occurs regularly. Additionally, the process of obtaining and protecting patents,
including defending allegations of patent infringement, can be costly and
time-consuming.
Ability to Forecast and Manage Working Capital Requirements
The Company remains significantly dependent on its revolving credit
facility. Various factors, including delays in new product development and
introductions, new product introduction by competitors, delays in regulatory
approvals and delays in the expansion of sales and distribution channels can
significantly affect management's ability to accurately forecast and manage its
working capital requirements.
Significant Accounting Policies -
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned domestic and foreign subsidiaries. All
significant intercompany accounts and transactions have been eliminated. The
Company accounts for its investment in the Orthopaedic Tissue Technology, L.L.C.
("OTT") joint venture under the equity method of accounting.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclose contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Page 69 of 119
<PAGE>
Cash and Cash Equivalents
Cash and cash equivalents include all cash balances and short-term
investments with original maturities of three months or less.
Allowance for Returns
An allowance is maintained for anticipated future returns of products sold
by the Company. An allowance for returns of approximately $0.7 million and $0.6
million is included as a reduction of trade receivables at December 31, 1997 and
December 31, 1996, respectively.
Inventories
Inventories are stated at the lower of cost or market, with cost being
determined using the first-in, first-out ("FIFO") method. Inventory reserves are
established to reduce the carrying amount of obsolete and excess inventory to
its net realizable value. The Company principally follows an inventory reserve
formula that reserves inventory balances based on historical and forecasted
sales.
Management has made its best estimate in determining the required level of
the inventory reserves discussed above and does not expect any material changes
thereto; however, given the subjective nature of the reserves, the Company's
estimate of the required reserves could change in the future.
Property and Depreciation
Property, plant and equipment are carried at cost. Depreciation is provided
on a straight-line basis over estimated useful lives of 15 to 20 years for land
improvements, 10 to 40 years for buildings, 3 to 11 years for machinery and
equipment, and 4 to 14 years for furniture, fixtures and equipment. Expenditures
for major renewals and betterments that extend the useful life of the assets are
capitalized. Maintenance and repair costs are charged to expense as incurred.
Upon sale or retirement, the asset cost and related accumulated depreciation are
eliminated from the respective accounts, and any resulting gain or loss is
included in income.
Instruments used by surgeons in the implantation of the Company's products
that are permanently held by distributors and subsidiaries are included in
property, plant and equipment and depreciated on a straight-line basis over
periods not to exceed five years with adjustments made as necessary for
identified impairments in carrying value.
Page 70 of 119
<PAGE>
Goodwill and Other Intangible Assets
The cost of intangible assets is amortized over the estimated periods
benefited, but not exceeding 40 years. The realizability of goodwill and other
intangibles is evaluated periodically as events or circumstances indicate a
possible inability to recover their carrying amount. Such evaluation is based on
various analyses, including cash flow and profitability projections. These
analyses necessarily involve significant management judgement. At December 31,
1997, management believes that the carrying value of its goodwill and other
intangibles is realizable.
Income Taxes
Income taxes are accounted for pursuant to the provisions of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes." This
statement requires the use of the liability method of accounting for deferred
income taxes. The provision for income taxes includes federal, foreign, and
state income taxes currently payable and those deferred because of temporary
differences between the financial statement and tax bases of assets and
liabilities. Provisions for federal income taxes are not made on the
undistributed earnings of foreign subsidiaries where the subsidiaries do not
have the capability to remit earnings in the foreseeable future and when
earnings are considered permanently invested. Undistributed earnings of foreign
subsidiaries at December 31, 1997 are insignificant.
Research and Development Costs
Research and development costs are charged to expense as incurred or when
expenditures for such costs are contractually obligated and the amount is
determinable.
Foreign Currency Translation
Revenues and expenses for foreign activities are translated at average
exchange rates during the period. Assets (primarily inventories and receivables)
located outside the U.S. are translated into U.S. dollars using end-of-period
exchange rates. The cumulative foreign currency translation adjustment at
December 31, 1997 and 1996 is not significant.
Earnings Per Share
During 1997, the Company adopted Statement of Financial Accounting
Standards No. 128, "Earnings per Share". Basic loss per
Page 71 of 119
<PAGE>
share of common stock is computed by dividing net loss, plus preferred stock
dividends and accretion, by the weighted average common shares outstanding
during the period. Because of the net loss applicable to common stock, diluted
loss per share of common stock has not been computed as the effect of the
assumed exercise of common stock equivalents would be anti-dilutive.
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
- Cash and cash equivalents - The carrying amount approximates fair
value because of the short maturities of the cash equivalents.
- Long-term debt - The fair value of the 11 3/4% Senior Secured Step-Up
Notes was approximately $85.9 million at December 31, 1997 and the
fair value of the 10 3/4% Senior Secured Notes was approximately
$85.9 at December 31, 1996, based upon market quotes provided by an
investment banker. The carrying amount of these notes was
approximately $84.6 million and $84.4 million at December 31, 1997
and 1996, respectively.
- Series B and C preferred stock - These are specialized instruments
with various terms and preferential treatment which render it
impracticable to determine their current fair value.
- Noncurrent distributor receivables - The fair value is based upon
the anticipated cash flows discounted at rates currently established
by management. The fair value of these receivable balances at December
31, 1997 and 1996 approximates book value.
Reclassifications
Certain prior year amounts have been reclassified to conform to the 1997
presentation.
Page 72 of 119
<PAGE>
2. ACQUISITIONS OF BUSINESSES
R&B Orthopaedics, Incorporated / Rock Surgical, Incorporated
During 1997, the Company entered into an Asset Purchase Agreement to
purchase all assets related to the sale, marketing and distribution of medical
devices with R&B Orthopaedics, Incorporated, a West Virginia corporation, and
Rock Surgical, Incorporated, a Delaware corporation (collectively, "OMI"). In
late 1997, the Company decided to enter into a settlement agreement with OMI to
terminate the Asset Purchase Agreement which was executed January 22, 1998. The
settlement agreement created a Distributor Agreement between the Company and OMI
effective January 1, 1998.
Orthopaedic Tissue Technology, L.L.C.
On July 12, 1996 the Company and Tissue Engineering, Inc. ("TEI") entered
into a joint venture agreement to create OTT. The Company executed $1.5 million
promissory notes on July 12, 1997 and July 12, 1996. Pursuant to these notes,
the Company provided funding of $1.7 million and $0.6 million in 1997 and 1996,
respectively. The Company will execute another $1.5 million promissory note and
provide funding of approximately $1.6 million to OTT during 1998. TEI
contributed to OTT its license to certain proprietary technology. The Company
has a 49% equity interest in OTT and receives 50% of OTT's annual profit/
losses. OTT is developing and will distribute biological products for
musculoskeletal applications. Products are designed to reproduce the events of
tissue formation including the treatment of medical conditions involving
disease, injury or deterioration of ligaments, tendons, cartilage or bone and
sports related injuries. The Company accounts for its investment in OTT under
the equity method of accounting and has reflected the present value of its
future funding commitments as a liability in the accompanying consolidated
financial statements.
U.S. Gypsum
On September 30, 1996, the Company entered into an Asset Purchase Agreement
to purchase the biomaterials business of the Industrial Gypsum Division of
United States Gypsum Company ("USG"). The Company paid $750,000 for this
business in four quarterly installments. The purchase price was principally
allocated to existing patents and is being amortized over 4 years. The Company
pays USG a royalty of 6% of sales, net of commissions, on this product.
Page 73 of 119
<PAGE>
3. INVENTORIES
<TABLE>
The components of inventories, net of reserves, are as follows (in
thousands):
<CAPTION>
December 31,
--------------------------
1997 1996
--------------------------
<S> <C> <C>
Raw materials $ 2,520 $ 2,214
Work in process 10,716 10,186
Finished goods 33,312 36,388
Surgical instruments 12,342 10,319
--------------------------
$ 58,890 $ 59,107
==========================
</TABLE>
In April 1996, the Company instituted a new surgical instrument program
with its domestic distributor network. The program makes more of the Company's
surgical instruments available for sale to its distributors and, thus, reduces
the demand for loaner instruments.
Generally, the Company's products are subject to regulation by the FDA.
Currently, management believes that the Company's products comply with
applicable FDA regulations and that the Company has no significant inventory
levels of products awaiting FDA approval that, if such approvals were denied,
would have a material effect on the consolidated financial position or operating
results of the Company.
4. PROPERTY, PLANT AND EQUIPMENT
<TABLE>
Property, plant and equipment consists of the following (in thousands):
<CAPTION>
December 31,
-----------------------
1997 1996
-----------------------
<S> <C> <C>
Land and land improvements $ 844 $ 844
Buildings 5,961 5,696
Machinery and equipment 28,255 25,036
Furniture, fixtures and equipment 13,351 13,033
Loaner instruments 14,761 14,174
-----------------------
63,172 58,783
Less: Accumulated depreciation (36,440) (25,124)
-----------------------
$ 26,732 $ 33,659
=======================
</TABLE>
Page 74 of 119
<PAGE>
5. INTANGIBLE ASSETS
<TABLE>
Other assets include certain intangible assets as follows (in thousands):
<CAPTION>
December 31,
----------------------
1997 1996
----------------------
<S> <C> <C>
Excess of cost over net assets acquired $ 35,032 $ 35,461
Distribution network 4,800 4,800
Patents, licenses and trademarks 3,350 3,137
Other 2,987 3,004
----------------------
46,169 46,402
Less: Accumulated amortization (11,269) (8,528)
----------------------
$ 34,900 $ 37,874
======================
</TABLE>
Excess of cost over net assets acquired is being amortized over periods
ranging from 10 to 40 years on a straight-line basis. Other intangibles are
being amortized over periods ranging from 2 to 25 years on either a
straight-line or double declining balance basis.
6. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
<TABLE>
A detail of accrued expenses and other current liabilities is as follows
(in thousands):
<CAPTION>
December 31,
----------------------
1997 1996
----------------------
<S> <C> <C>
Interest $ 5,205 $ 4,668
Employee benefits 1,123 3,489
Joint venture 1,500 2,105
Commissions 1,278 1,358
Taxes 988 761
Distributor product reserve - 161
Professional fees 2,731 1,088
Other 3,920 4,823
----------------------
$ 16,745 $ 18,453
======================
</TABLE>
Page 75 of 119
<PAGE>
7. LONG-TERM DEBT AND SHORT-TERM BORROWINGS
<TABLE>
Long-term debt consists of the following (in thousands):
<CAPTION>
December 31,
------------------------
1997 1996
------------------------
<S> <C> <C>
11 3/4% Series D Senior Secured
Step-Up Notes, net of
unamortized discount of $409 $ 84,591 $ -
10 3/4% Series B Senior Secured
Notes, net of unamortized
discount of $572 - 84,428
Capital lease obligations 835 378
------------------------
85,426 84,806
Less current portion (322) (138)
------------------------
$ 85,104 $ 84,668
========================
</TABLE>
Through August, 1997, the Company had outstanding 10 3/4% Series B Senior
Secured Notes (Series B Notes) with an original principal balance of $85
million. The Series B Notes had 350,000 of common stock purchase warrants which
had been sold for $.02 per warrant.
On August 7, 1997, the Company completed an exchange of its Series B Notes
for the 11 3/4% Series C Senior Secured Step-Up Notes (the "Series C Notes").
The terms of those Series C Notes are governed by a new indenture which is
similar to the indenture for the Series B Notes except that i) the Series B
Notes bear interest at 10 3/4% and the Series C Notes bear interest at 11 3/4%
which may increase to 12 1/4% on the first anniversary of the effective date of
the exchange offer under certain circumstances, ii) the new indenture does not
contain any sinking fund requirements, and iii) certain covenants in the new
indenture are less restrictive than those in the previous indenture,
specifically (1) consolidated net worth, as defined, does not require a
deduction for accrued dividends on the Company's Series B and Series C Preferred
Stock, and (2) the limit on purchase money indebtedness is $10 million as
opposed to $5 million in the previous indenture.
The Series C Notes were issued pursuant to a Registration Rights Agreement
whereby the Company agreed to use its best efforts to effect a registration
statement for a new issue of the senior secured notes of the Company that are
identical in all respects to the Series C Notes. On November 3, 1997 the Company
completed an exchange offer of its Series C Notes for the 11 3/4% Series D
Senior Secured Step-Up
Page 76 of 119
<PAGE>
Notes (the "Series D Notes"). The terms of the Series D Notes are the same as
the Series C Notes except that the Series D Notes are registered securities.
The Series D Notes mature on July 1, 2000 and are subject to redemption at
the option of the Company, in whole or in part, upon not less than 30 nor more
than 60 days notice, at the redemption prices (expressed as percentages of
principal amount) set forth below plus accrued and unpaid interest thereon to
the applicable redemption date, if redeemed during the following periods:
Date Percentage
July 1, 1997 - June 30, 1998 103%
July 1, 1998 and thereafter 100%
The indenture contains specific restrictions that apply to the Series D
Notes which limit, among other things, (a) the issuance of additional debt by
the Company or any of its subsidiaries, (b) the issuance of disqualified stock
by the Company or any preferred stock by any of its subsidiaries, (c) the
payment of cash dividends on, and redemption of, capital stock of the Company,
(d) consolidations, mergers or transfers of all or substantially all of the
Company's assets, and (e) transactions with affiliates. The indenture also
requires the Company to maintain a minimum consolidated net worth, as defined,
of $17.5 million in 1997 and $20 million in 1998 and any year thereafter.
The Series D Notes are secured by certain fixed assets, intellectual
property rights and other intangible assets of the Company, now in existence or
hereafter acquired.
The Company has available to it a $30 million revolving line of credit
under an agreement with Sanwa Business Credit Corporation ("Sanwa Agreement")
that will expire in September, 1999. As of December 31, 1997, this agreement
provided an eligible borrowing base of $29.1 million. The Company had drawn
$18.5 million against the Sanwa line of credit as of December 31, 1997. During
1997, borrowings under the Sanwa Agreement averaged $18.1 million with a maximum
amount borrowed of $22.6 million, as compared to 1996 when borrowings (under the
Sanwa Agreement and prior revolving credit line agreement) averaged $12.5
million with a maximum amount borrowed of $16.1 million. Borrowings under this
agreement are collateralized by the Company's accounts receivable and
inventories and bear interest at prime plus 1.5% (10% at December 21, 1997). A
guaranty fee of 3% per annum is required on any related letter of credit
guaranties.
Page 77 of 119
<PAGE>
The Sanwa Agreement places various restrictions on the Company which limit,
among other things, (a) additional indebtedness, (b) acquisitions, (c)
consolidations, mergers, sales of all or substantially all of the Company's
assets and (d) transactions with affiliates. Additionally, the Company must meet
a specified quarterly cash flow coverage ratio.
8. CAPITAL STOCK
Common Stock
Two classes of common stock of the Company have been authorized for
issuance: Class A Common Stock and Class B Common Stock. The holders of Class A
Common Stock are entitled to one vote for each share of Class A Common Stock.
There are currently no shares of Class B Common Stock outstanding. Subject to
any preferential rights of any outstanding series of preferred stock designated
by the Board of Directors, the holders of Class A Common Stock are entitled to
receive, ratably, with the holders of any Class B Common Stock, such dividends,
if any, as may be declared from time to time by the Board of Directors.
Pursuant to a restated certificate of incorporation dated September 25,
1995 (the "Restated Certificate"), the Company has 47,000,000 authorized shares
of common stock consisting of 46,000,000 shares of Class A Common Stock and
1,000,000 shares of Class B Common Stock.
Preferred Stock
Pursuant to the Restated Certificate, the Company has 3,000,000 authorized
shares of preferred stock consisting of 1,200,000 shares of Series A Preferred
Stock, 800,000 shares of Series B Preferred Stock, 350,000 shares of Series C
Preferred Stock, and 650,000 shares of undesignated preferred stock. The Series
C Preferred Stock is senior to the Series A Preferred Stock and junior to the
Company's Series B Preferred Stock with respect to dividends and rights upon
liquidation.
The Series A Preferred Stock is voting stock and, upon liquidation or
dissolution of the Company, entitles the holders to a preferential distribution,
subordinate to the Series B and Series C Preferred Stock, from the assets
legally available for distribution to stockholders after the payment of all
debts and liabilities of the Company. At December 31, 1997, the aggregate
preferential distribution would amount to $25.2 million, including accrued and
unpaid dividends ($8.7 million).
Page 78 of 119
<PAGE>
Dividends on the Series A Preferred Stock accumulate at the rate of 12% per
annum for a five-year period and at the rate of 15% per annum thereafter,
subject to escalation in the event of delinquency in the payment of the
dividends; as of December 31, 1997, the dividend rate had escalated to 18.88%
per share. Dividends can be paid on the Series A Preferred Stock at the
Company's discretion and the Series A Preferred Stock is redeemable at any time
at the option of the Company; such dividend and redemption rights are currently
restricted, however, by a provision set forth in the indenture relating to the
Series D Notes.
Certain holders of the Company's Series A Preferred Stock waived all rights
and claims to those Series A Preferred Stock dividends that accrued since
January 1, 1997 to date or that would accrue during 1998. Dividends that would
accrue in 1999 and 2000 will also be waived to the extent necessary as
determined by the Company's independent auditors. The amount waived was $3.0
million for 1997.
On July 29, 1994, the Company and California Public Employees' Retirement
System ("CalPERS") entered into a Series B Preferred Stock Purchase and Class A
Common Stock Warrant Agreement whereby the Company would have the option, for a
period of 30 months after July 29, 1994, to sell up to $60 million of Series B
Preferred Stock to CalPERS. On July 29, 1994, the Company sold 150,000 shares of
the Series B Preferred Stock and 254,684 warrants to purchase Class A Common
Stock to CalPERS for $15 million. On October 31, 1994, the Company sold 450,000
shares of Series B Preferred Stock and 764,053 warrants to purchase Class A
Common Stock to CalPERS for $45 million. Each warrant (exercise price of $.001
per share) entitles CalPERS to purchase from the Company one share of Class A
Common Stock at any time. The Company may be required to issue additional
warrants to CalPERS to allow CalPERS to achieve a certain return on its
investment in the Company.
On August 12, 1997, CalPERS consented to increase the aggregate number of
Class A Common Stock that is issuable pursuant to the Company's Restated
Certificate of Incorporation by 800,000 shares. In exchange, the Company agreed
to grant CalPERS warrants to purchase up to 73,935 shares of Class A Common
Stock on the same terms and conditions as CalPERS' present warrants. These
warrants are to be issued on a quarterly basis and in an amount equal to 8.7% of
the quarterly totals (so as not to dilute CalPERS' common stock ownership). As a
result, the Company issued warrants to CalPERS for the purchase of 51,701 shares
and 5,786 shares of Class A Common Stock for the quarterly periods ending
September 30, 1997 and December 31, 1997, respectively.
Page 79 of 119
<PAGE>
The Series B Preferred Stock is non-voting and, upon liquidation or
dissolution of the Company, the holders of the Series B Preferred Stock are
entitled to a preferential distribution from the assets legally available for
distribution to stockholders after the payment of all debts and liabilities of
the Company. As of December 31, 1997, such aggregate preferential distribution
would amount to $83.0 million, including accrued and unpaid dividends ($3.0
million).
Dividends on the Series B Preferred Stock are payable on January 2 and July
1 of each year, subject to the dividend restrictions in the indenture relating
to the Series B Notes. The dividend rate, originally $10.00 per share, is
subject to escalation in the event the Company elects to defer the payment of
the dividends; as of December 31, 1997, the dividend rate was $10.00 per share.
The Company has the option to pay dividends in either cash or additional shares
of Series B Preferred Stock.
On February 25, 1997, the Company's Board of Directors declared a dividend
"in-kind" of $11.2 million to the Series B Preferred Stock shareholders by
issuing 111,910 shares of Series B Preferred Stock to shareholders of record as
of December 31, 1996. Accordingly, this "in-kind" dividend has been reflected in
the carrying amount of the Mandatorily Redeemable Series B Preferred Stock in
the accompanying consolidated balance sheet. Subsequently, the Company declared
additional "in-kind" dividends of $5.3 million and $3.5 million by issuing
53,485 shares and 34,605 shares of Series B Preferred Stock to its Series B
Preferred Stock shareholders of record as of February 28, 1997 and October 1,
1997, respectively.
The Series B Preferred Stock is subject to an optional redemption by the
Company. The Company must pay a premium of 5% if such redemption occurs before
July 29, 1999. Unless earlier redeemed, the Company must redeem all Series B
Preferred Stock on July 29, 2002. The Series B Preferred Stock also may be
redeemed at the option of the holder in certain circumstances. The terms of the
Series B Preferred Stock limit, among other things, (a) the issuance of
additional capital stock, (b) consolidations, mergers, transfers or sales of all
or substantially all of the Company's assets, (c) payment of dividends on and
redemption of the Company's capital stock, and (d) additional indebtedness.
On September 25, 1995, the Company and Princes Gate Investors, L.P. and
affiliates, investment partnerships managed by Morgan Stanley & Co. Incorporated
(collectively, the "Princes Gate Investors") entered into a Securities Purchase
Agreement, pursuant to which the Princes Gate Investors purchased, for an
aggregate sum of $35 million ($33.8 million net of commissions), 350,000 shares
of preferred stock
Page 80 of 119
<PAGE>
designated Redeemable Convertible Preferred Stock, Series C (the "Series C
Preferred Stock") and 741,110 warrants to purchase Class A Common Stock (the
"Series B Warrants").
The Series C Preferred Stock is senior to the Company's Class A Common
Stock and Series A Preferred Stock and junior to the Company's Series B
Preferred Stock with respect to dividends and rights upon liquidation. The
Series C Preferred Stock is non-voting and, upon liquidation of the Company, the
holders of the Series C Preferred Stock are entitled to a preferential
distribution from the assets legally available for distribution to stockholders
after the payment of all debts and liabilities of the Company and all
liquidation payments to the holders of the Series B Preferred Stock, including
all accrued and unpaid dividends (the "Series C Redemption Amount"). As of
December 31, 1997, the Series C Redemption Amount was $44.5 million, including
accrued and unpaid dividends ($9.5 million).
Dividends on the Series C Preferred Stock, which are payable on January 1,
April 1, July 1 and October 1 of each calendar year, cumulate at the rate of
$12.00 per share per annum through March 24, 1999. The dividend rate per share
per annum increases according to the following schedule:
March 25, 1999 to September 24, 1999 $13.00
September 25, 1999 to March 24, 2000 14.00
March 25, 2000 to September 24, 2000 15.00
September 25, 2000 to March 24, 2001 16.00
March 25, 2001 and thereafter 17.00
Under the terms of the Company's indenture relating to the Series D Notes,
dividends on the Series C Preferred Stock may not be paid until the Series D
Notes are paid in full and, under the Restated Certificate, dividends on the
Series C Preferred Stock are subject to the prior payment of dividends on and,
under certain circumstances, redemption of the Series B Preferred Stock.
At any time after March 24, 1999, the Princes Gate Investors, holding not
less than 66-2/3% of all Series C Preferred Stock, have the right to convert the
Series C Preferred Stock into shares of Class A Common Stock having a fair
market value, as defined, equal to 110% of the Series C Redemption Amount on
that date. After any such conversion, no new shares of Series C Preferred Stock
may be issued by the Company. Additionally, subject to certain limitations
imposed by the Restated Certificate and the Series D Notes, the Series C
Page 81 of 119
<PAGE>
Preferred Stock is redeemable at the option of the Company for an amount equal
to the Series C Redemption Amount on the date of any such redemption.
The terms of the Series C Preferred Stock, contain certain covenants that,
among other things, limit the Company's ability to (a) issue additional shares
of preferred stock, (b) incur additional indebtedness and (c) consolidate, merge
or sell substantially all of the Company's assets.
Each of the Series B Warrants entitles the holder thereof to purchase one
share of Class A Common Stock at an exercise price of $.01 per share. The
Company will be required to issue additional Series B Warrants upon the
occurrence of certain events as follows: If 1) the Company has not repurchased,
redeemed or converted all outstanding Series C Preferred Stock on or before
March 25, 1999, or 2) prior to March 25, 1999, an initial public offering has
occurred and all of the proceeds from such offering are not used to redeem
outstanding shares of Series C Preferred Stock, then on the earlier of (1) or
(2) above, additional Series B Warrants shall be issued, if Series C Preferred
Stock is still outstanding; provided, however, that at no time is the Company
required to issue more than an aggregate of 3,989,931 Series B Warrants.
In September 1995, the Company also issued an additional 125,000 warrants
(exercise price of $.001 per share) to purchase Class A Common Stock to the
holders of the Company's Series B Preferred Stock. These warrants were issued in
exchange for the consent of the holders of the Series B Preferred Stock to the
issuance of the Series C Preferred Stock.
Warrants
In addition to the warrants issued to CalPERS and Princes Gate Investors,
the Company issued warrants to the purchasers of its senior secured notes at the
purchase price of $.02 per warrant. In the aggregate, the warrants entitle the
holders to purchase 350,000 shares of the Company's Class A Common Stock at
$.142 per share. The exercise price and the number of warrant shares are both
subject to adjustment in certain cases. The warrants are exercisable at any time
and, unless exercised, the warrants will automatically expire ten years from the
date of issuance.
The holders of the warrants have no voting or dividend rights. The holders
of the warrants are not entitled to share in the assets of the Company in the
event of liquidation or dissolution of the Company. In case of certain
consolidations or mergers of the Company, or the
Page 82 of 119
<PAGE>
sale of all or substantially all of the assets of the Company to another
corporation, each warrant shall thereafter be exercisable for the right to
receive the kind and amount of shares of stock or other securities or property
to which such holder would have been entitled as a result of such consolidation,
merger or sale had the warrants been exercised immediately prior thereto.
Stock Option Plans
At December 31, 1997, the Company has two fixed stock option plans for
employees, two stock option plans for nonemployees which principally include the
distributors of the Company's products and a distributor stock purchase plan.
Generally, the Company's stock option plans grant options to purchase the
Company's Class A Common Stock and, in certain instances, the Company's Series A
Preferred Stock.
Under the 1993 Stock Option Plan, as adopted June 29, 1993, the Company was
authorized to grant options to purchase up to 1.5 million shares of Class A
Common Stock. Pursuant to CalPERS' consent (on August 12, 1997) to increase the
aggregate number of Class A Common Stock issuable by 800,000, the Board resolved
to reserve 370,000 shares of this increase for issuance under the 1993 Stock
Option Plan. As a result, the Company may grant options to its employees for up
to 1.87 million shares of Class A Common Stock under the 1993 Stock Option Plan.
Under the 1993 Special Stock Option Plan, the Company may grant options to its
employees up to 200,000 shares of common stock and 20,000 shares of preferred
stock. Under these two fixed stock option plans, options generally become
exercisable in installments of 25% annually in each of the first through fourth
anniversaries of the grant date and have a maximum term of ten years. Under both
plans, the exercise price of each option equals the market price, as internally
determined based on certain factors, of the Company's respective stock on the
date of grant.
The Company's non-employee stock option plans include the 1994 Non-employee
Stock Option Plan ("NSOP") and the 1994 Distributor Stock Option Plan ("DSOP").
Under the NSOP, the Company may grant up to 125,000 shares of Class A Common
Stock and up to 500,000 shares of Class A Common Stock under the DSOP, as
adopted January 1, 1994. As the result of CalPERS' consent to increase the
aggregate number of Class A Common Stock issuable by 800,000, the Board resolved
to reserve 70,000 shares of this increase for issuance under the DSOP, thereby
increasing the authorized shares under the DSOP from 500,000 to 570,000. Under
both of these plans, the exercise price of each option equals the market price
of the Company's Common Stock on the date of grant with the options maximum term
equaling ten years. Under
Page 83 of 119
<PAGE>
the NSOP, options generally become exercisable in installments of 25% annually
in each of the first through fourth anniversaries of the grant date. Under the
DSOP, options generally become exercisable upon the achievement of a specified
performance target.
<TABLE>
A summary of the Company's fixed and non-employee stock option plans as of
December 31, 1995, 1996 and 1997, and changes during the years ending on those
dates is as follows:
<CAPTION>
1995 1996 1997
----------------- ----------------- ------------------
Weighted Weighted Weighted
Average Average Average
Class A Shares Exercise Shares Exercise Shares Exercise
Common Stock (000's) Price (000's) Price (000's) Price
<S> <C> <C> <C> <C> <C> <C>
Balance,
Beginning of year 1,635.3 $3.09 1,822.2 $8.78 1,672.1 $10.53
Granted 624.5 19.28 204.7 21.00 1,511.5 6.58
Exercised (330.5) 0.14 (123.0) 0.14 (157.5) 0.14
Lapsed/ Canceled (107.1) 9.66 (231.8) 11.57 (1,166.5) 16.53
Balance,
End of year 1,822.2 8.78 1,672.1 10.53 1,859.6 4.47
</TABLE>
<TABLE>
<CAPTION>
1995 1996 1997
----------------- ----------------- -----------------
Weighted Weighted Weighted
Average Average Average
Series A Shares Exercise Shares Exercise Shares Exercise
Preferred Stock (000's) Price (000's) Price (000's) Price
<S> <C> <C> <C> <C> <C> <C>
Balance,
Beginning of year 14.8 $19.88 17.0 $19.88 13.8 $19.88
Granted 3.3 19.88 - - 4.7 19.88
Exercised (0.5) 19.88 - - - -
Lapsed/ Canceled (0.5) 19.88 (3.3) 19.88 (0.2) 19.88
Balance,
End of year 17.0 19.88 13.8 19.88 18.2 19.88
</TABLE>
Page 84 of 119
<PAGE>
<TABLE>
The following table summarizes information concerning the Company's stock
option plans at December 31, 1997:
<CAPTION>
Weighted
Average
Remaining Weighted Weighted
Range of Contractual Average Average
Exercise Number Life Exercise Number Exercise
Prices Outstanding (years) Price Exercisable Price
<S> <C> <C> <C> <C> <C>
$0.14 405,375 5.84 $0.14 303,375 $0.14
$5.00 1,347,930 8.06 $5.00 537,276 $5.00
$7.50 18,880 6.45 $7.50 18,880 $7.50
$8.48 4,500 6.62 $8.48 4,500 $8.48
$13.77 14,800 6.93 $13.77 14,800 $13.77
$16.57 39,000 7.12 $16.57 34,320 $16.57
$20.13 15,600 7.38 $20.13 8,933 $20.13
$21.00 13,500 8.16 $21.00 3,967 $21.00
</TABLE>
As allowed under SFAS No. 123, the company applies APB Opinion 25 and
related Interpretations in accounting for its stock option plans. Accordingly,
no compensation cost has been recognized for its fixed stock option plans. Also,
no compensation cost has been recognized under the Company's non-employee stock
option plans during 1995, however, approximately $653,000 and $126,000 of
compensation cost was recognized in the accompanying consolidated statement of
operations for the years ended December 31, 1997 and 1996, respectively related
to the non-employee stock option plans. Had compensation cost for the Company's
stock-based compensation plans been determined based on the fair value at the
grant dates for awards under those plans consistent with SFAS No. 123, the
Company's net loss and earnings per share would have been increased to the
following pro forma amounts (in thousands, except per share amounts):
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C> <C>
Net loss As reported $(22,572) $(14,589) $(6,492)
Pro forma $(23,968) $(15,554) $(7,356)
Loss Per Share As reported $(4.38) $(3.90) $(2.24)
Pro forma $(4.53) $(4.00) $(2.35)
</TABLE>
The fair value of each option is estimated on the date of grant using the
minimum value methodology promulgated by SFAS No. 123. The weighted average fair
value of options granted during 1997, 1996 and
Page 85 of 119
<PAGE>
1995 were $3.97, $9.62 and $9.03, respectively. This methodology is used as the
Company's shares are not publicly traded. In applying the minimum value
methodology, the Company utilized a risk free interest rate that varied between
3.38% and 7.50% for 1997, 1996 and 1995 grant dates and expected lives of the
options of 10 years for 1997, 1996 and 1995.
Employees' Common Stock Grant Plan
The Company has an Employees' Common Stock Grant Plan of which 122,500
shares are reserved for issuance under this plan. No grants have been made
during 1997, 1996 and 1995.
Distributor Stock Purchase Plan
During 1993, the Company established a Stock Purchase Plan for its
distributors pursuant to which shares of Class A Common Stock and Series A
Preferred Stock were offered to the Company's distributors for a purchase price
of $.142 and $19.88, respectively, per share. As of December 31, 1997, 417,000
shares of Class A Common Stock and 39,450 shares of Series A Preferred Stock
purchased under this plan were outstanding. Shares purchased under this plan
vest on December 31, 1999, or earlier if certain criteria are met. As of
December 31, 1997, 369,510 shares of Class A Common Stock and 34,701 shares of
Series A Preferred Stock were vested. These shares are subject to repurchase by
the Company in the event that a distributor's association with the Company is
terminated or if the distributor is no longer operating as an exclusive sales
representative for the Company. The repurchase price shall be the distributor's
cost to purchase the shares until the shares vest; thereafter, the repurchase
price shall be at fair market value.
9. INCOME TAXES
<TABLE>
Consolidated loss before income taxes consists of the following (in
thousands):
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
United States $(21,045) $(10,525) $(4,403)
Foreign (1,527) (4,064) (470)
---------- ---------- ----------
$(22,572) $(14,589) $(4,873)
========== ========== ==========
</TABLE>
Page 86 of 119
<PAGE>
<TABLE>
The provision for income taxes consists of the following (in thousands):
<CAPTION>
1997 1996 1995
------------------------------------
<S> <C> <C> <C>
Current - Foreign $ (187) $ (1,278) $ 351
Deferred (5,472) (1,603) 2,167
Tax benefit of operating
loss carryforward (2,274) (1,495) (3,426)
Adjustment to valuation allowance 7,933 4,376 2,527
------------------------------------
$ - $ - $ 1,619
====================================
</TABLE>
<TABLE>
The income tax provision differs from the amount computed by applying the
U.S. statutory federal income tax rate due to the following (in thousands):
<CAPTION>
1997 1996 1995
------------------------------------
<S> <C> <C> <C>
Income tax benefit at statutory rate $ (7,674) $ (4,911) $ (1,657)
Adjustment to valuation allowance 7,933 4,376 2,527
State income taxes (842) (415) (176)
Foreign income taxes 35 104 162
Goodwill amortization 556 560 584
Other, net (8) 286 179
------------------------------------
$ - $ - $ 1,619
====================================
</TABLE>
<TABLE>
The components of deferred taxes are as follows (in thousands):
<CAPTION>
1997 1996
--------------------------------
Deferred tax assets:
<S> <C> <C>
Operating loss carryforward $ 14,259 $ 9,718
Reserves and allowances 9,376 9,398
Depreciation 904 -
Intercompany profit on inventories 336 319
Other 6,120 4,577
---------------- ---------------
30,995 24,012
Valuation allowance (29,267) (21,334)
---------------- ---------------
$ 1,728 $ 2,678
================ ===============
Deferred tax liabilities:
Intangible assets $ 1,567 $ 1,700
Depreciation - 363
Other 161 615
---------------- ---------------
$ 1,728 $ 2,678
================ ===============
</TABLE>
Page 87 of 119
<PAGE>
The Company has provided a valuation allowance against its net deferred tax
assets because, given the Company's history of operating losses, the
realizability of these assets is uncertain. Management's assessment of the need
for a valuation allowance could change in the future based on the Company's
future operating results.
At December 31, 1997, the Company has a net operating loss carryforward for
U.S. federal income tax purposes of approximately $35.1 million which expires in
2009 through 2012. Additionally, the Company has credit carryforwards of
approximately $1,025,000 which expire through 2010.
10. EMPLOYEE BENEFIT PLANS
The Company sponsors a defined contribution plan which covers employees
that are 21 years of age and over. The Company has the option to contribute
annually to the plan shares of Company stock determined by the Board of
Directors and will match employee's voluntary contributions at rates of 100% of
the first 2% of an employee's annual compensation, and 50% of the next 2% of an
employee's annual compensation. Employees vest in the Company's contributions
after 5 years. The Company's cost related to this plan was approximately $2.5
million, $1.7 million and $1.7 million, respectively, for the years ended
December 31, 1997, 1996 and 1995.
11. COMMITMENTS AND CONTINGENCIES
Lease Commitments
<TABLE>
The Company leases certain equipment under capital leases and noncancelable
operating leases. The future annual minimum rental payments under these leases
are as follows (in thousands):
<CAPTION>
Capital Operating
Year Leases Leases
---- -------------- ---------------
<S> <C> <C> <C>
1998 $ 339 $ 690
1999 315 400
2000 271 203
2001 34 70
2002 8 -
-------------- ---------------
Total minimum lease payments 967 $ 1,363
===============
Less amount representing interest (132)
--------------
Present value of future lease payments $ 835
==============
</TABLE>
Page 88 of 119
<PAGE>
Rental cost under operating leases for the years ended December 31, 1997,
1996 and 1995 was approximately $1.3 million, $1.2 million, and $1.3 million,
respectively.
Concentration of Credit Risk
Substantially all of the Company's sales and trade receivables are
concentrated with hospitals and physicians. The Company maintains reserves for
potential credit losses on trade receivables, which are generally not
collateralized.
Legal Proceedings
DCW, pursuant to the DCW Acquisition agreements, retains liability for
matters arising from certain conduct of DCW prior to the Company's acquisition
on June 30, 1993, of substantially all the assets of the large joint orthopaedic
implant business of DCW. As such, DCW has agreed to indemnify the Company
against all liability for all products manufactured prior to the Acquisition
except for products provided under the Company's 1993 agreement with DCW
pursuant to which the Company purchased certain small joint orthopaedic implants
for worldwide distribution. However, the Company was notified in May 1995 that
DCW, which filed for reorganization under Chapter 11 of the U.S. Bankruptcy
Code, would no longer defend the Company in such matters until it received
further direction from the bankruptcy court. On December 2, 1996 DCW filed a
proposed plan of reorganization that provided that all commercial creditors be
paid 100% of their claims, plus interest. The plan did not however indicate
whether DCW would affirm or reject the Acquisition agreements. This plan of
reorganization was rejected. Accordingly, there can be no assurance that Dow
Corning will indemnify the Company on any claims in the future. Although the
Company does not maintain insurance for claims arising on products sold by DCW,
management does not believe the outcome of any of these matters will have a
material adverse effect on the Company's financial position or results of
operations.
Mitek Surgical Products, Inc. ("Mitek"), has alleged in the Federal
District Court for the Northern District of California that the Company's
ANCHORLOK(R) soft tissue anchor infringes its patent. That court recently
rendered an opinion of non-infringement in favor of the Company, which opinion
was reversed on November 3, 1997, after reconsideration by the Court. On July
18, 1997, Howmedica, Inc. alleged in the Federal District Court for the District
of New Jersey that certain of the Company's products infringe its patent related
to a type of porous coating and seeks unspecified monetary damages. The Company
is defending that claim. On August 22, 1997, Osteonics, Inc.
Page 89 of 119
<PAGE>
alleged in the Federal District Court for the District of New Jersey that the
Company's BRIDGE(R) Hip System infringes its patent and seeks money damages and
injunctive relief. The Company is defending that claim. Management does not
believe the outcome of any of these matters will have a material adverse effect
on the Company's financial position or results of operations.
The Company is not involved in any other pending litigation of a material
nature that would have a material adverse effect on the Company's financial
position or results of operations.
Other
On February 22, 1996, the Company entered into a Distribution Agreement
with a Japanese corporation whereby the Company received $3 million in exchange
for 60,000 shares of the Company's Class A Common Stock and the exclusive rights
to distribute the Company's products in Japan for an initial period of five
years, with a possible extension for an additional five years subject to the
achievement of certain sales goals. In connection with this Distribution
Agreement, the Company is amortizing $1,740,000 of the proceeds assigned to the
distribution rights to income ratably over 5 years. At December 31, 1997 and
1996, deferred income in the accompanying consolidated financial statements
related to this distribution right was $1,141,000 and $1,502,000, respectively.
During 1996, the Company decided to discontinue operations of certain
subsidiaries including Wright Medical Technology of Hong Kong Limited, Wright
Medical Technology de Brasil Importadora e Comercial Ltda, Wright Medical
Technology of Australia Pty Limited and Wright Medical Technology France
S.A.R.L. Also, during 1997, the Company decided to discontinue operations of its
subsidiary in the Virgin Islands. Discontinuance of those operations did not
have a material effect on the Company's consolidated operating results or
financial position.
On January 3, 1997, the Company entered into an agreement with Gary K.
Michelson, M.D., to purchase rights to patents, ideas and designs related to the
"MultiLock" design for an anterior cervical plating system. The purchase price
included a payment of $120,000 due in four installments in 1997, as well as
royalties equal to 8% of the sales, net of commissions, of the locking cam
products. The Company guaranteed minimum royalties as follows:
Page 90 of 119
<PAGE>
04/01/98 - 03/31/99 $320,000
04/01/99 - 03/31/00 $480,000
04/01/00 - 03/31/01 $700,000
04/01/01 - 03/31/02 $1,000,000
For each of the annual periods commencing April 1, 2002 through March 31 of
the subsequent year, and continuing for the longer of the period for which the
MultiLock products are being sold or 10 years from January 3, 1997, the minimum
royalty shall be $1.0 million.
The Company also entered into an agreement with Dr. Michelson to purchase
rights to patents, ideas and designs related to the "SingleLock" design for an
anterior cervical plating system. The purchase price included a payment of
$100,000 due in 1997, as well as royalties equal to 8% of the net sales of the
SingleLock products. The Company guaranteed minimum royalties as follows:
10/01/98 - 03/31/99 $80,000
04/01/99 - 03/31/00 $200,000
04/01/00 - 03/31/01 $295,000
04/01/01 - 03/31/02 $425,000
04/01/02 - 03/31/03 $500,000
and years thereafter
Dr. Michelson agreed to provide exclusive continuing services as a
developer, product lecturer and general consultant for anterior cervical
plating.
12. RELATED PARTY TRANSACTIONS
Stockholder Notes Receivable
As of December 31, 1997 and 1996, the Company has notes receivable from
stockholders aggregating approximately $1.0 and $1.0 million, respectively,
relating to purchases of the Company's common and preferred stock. On December
27, 1995, Herbert Korthoff, the Company's Chairman and then Chief Executive
Officer, and Barbara Korthoff repaid the outstanding principal balance of
$1,176,164 on 552,690 shares of Class A Common Stock and 55,269 shares of Series
A
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<PAGE>
Preferred Stock purchased through a note on June 30, 1993. A new non-interest
bearing note was issued for the unpaid interest on the above note of $420,480.
The remaining stockholder notes receivable bear interest at the rate of 10%
per annum, payable semi-annually. At the option of the maker, the interest may
be deferred and added to principal, and to date such interest has been added to
principal. The entire principal amount is due on June 30, 1998, subject to
acceleration upon a sale of all or substantially all of the business assets, or
issued and outstanding capital stock of the Company or the successful completion
of an initial public offering by the Company of any of its equity securities
pursuant to a registration statement under the Securities Act of 1933. The notes
are secured by a pledge of the related preferred and common stock. Approximately
$62,000, $62,000, and $178,000 respectively, of interest income relating to
stockholder notes receivable was recorded by the Company during the years ended
December 31, 1997, 1996 and 1995.
Distributor Notes Receivable
The Company has notes receivable from its distributors relating primarily
to the purchase of instruments used by surgeons in the implantation of the
Company's products. The notes are generally collateralized by the related
instruments. The outstanding balance on these notes was approximately $0.4
million and $0.4 million at December 31, 1997 and 1996, respectively, of which
the current portion (included in "other current assets" in accompanying balance
sheets) was $0.3 million and $0.3 million, respectively. Also, the Company has
notes receivable from its distributors relating to loans made to assist
distributors in growing their businesses. The outstanding balance on these notes
was approximately $1.1 million and $1.0 million at December 31, 1997 and 1996,
respectively, of which the current portion was $0.3 and $0.2, respectively.
During 1996, the Company repurchased certain surgical instruments owned by
distributors at the lower of the instruments' fair value or the related unpaid
note balance. This repurchase was done to implement the instrument program
discussed in Note 3 to the consolidated financial statements.
The accompanying statements of operations for the years ended December 31,
1997, 1996 and 1995, include approximately $0.8 million, $0.8 million, and $2.4
million, respectively, of net sales of instruments to distributors. Typically,
the Company has not reflected any gross margin on these instrument sales.
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<PAGE>
Management Agreement
The Company has a management agreement with an affiliate of one of its
principal stockholders pursuant to which the Company incurs annual management
fees of $360,000. As of August 1, 1997, the annual fee was modified to $260,000.
13. SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Following is a summary of the Company's noncash investing and financing
activities for the years ended December 31:
1995
- None
1996
- Issued 111,910 shares of Series B Preferred Stock in the form
of an "in-kind" dividend payment aggregating $11.2 million.
- Repurchased surgical instruments from distributors totaling
$6.8 million through the forgiveness of accounts owed by
distributors to the Company on such surgical instruments.
1997
- Issued 53,485 shares of Series B Preferred Stock in the form
of an "in-kind" dividend payment aggregating $5.3 million.
- Issued 34,605 shares of Series B Preferred Stock in the form
of an "in-kind" dividend payment aggregating $3.5 million.
Page 93 of 119
<PAGE>
14. INDUSTRY SEGMENT AND FOREIGN OPERATIONS
<TABLE>
The Company's operations are classified as a single industry segment.
Selected financial information by geographic area is as follows (in thousands):
<CAPTION>
United Elimi-
Year Ended December 31,1995 States Foreign nations Total
-------------------------------- --------------- --------------- --------------- ---------------
Net sales
<S> <C> <C> <C> <C>
Unaffiliated customers $ 109,046 $ 14,150 $ - $ 123,196
Intercompany 3,005 - (3,005) -
---------------- --------------- --------------- ---------------
Total $ 112,051 $ 14,150 $ (3,005) $ 123,196
---------------- --------------- --------------- ---------------
Operating income (loss) $ 5,308 $ 1,171 $ (176) $ 6,303
---------------- --------------- --------------- ---------------
Identifiable assets $ 159,871 $ 16,339 $ (1,839) $ 174,371
---------------- --------------- --------------- ---------------
Year Ended December 31,1996
Net sales
Unaffiliated customers $ 108,125 $ 13,743 $ - $ 121,868
Intercompany 5,375 - (5,375) -
---------------- --------------- --------------- ---------------
Total $ 113,500 $ 13,743 $ (5,375) $ 121,868
---------------- --------------- --------------- ---------------
Operating income (loss) $ (774) $ (3,289) $ 1,008 $ (3,055)
---------------- --------------- --------------- ---------------
Identifiable assets $ 167,458 $ 5,761 $ (6,893) $ 166,326
---------------- --------------- --------------- ---------------
Year Ended December 31,1997
Net sales
Unaffiliated customers $ 110,865 $ 11,532 $ - $ 122,397
Intercompany 5,731 - (5,731) -
---------------- --------------- --------------- ---------------
Total $ 116,596 $ 11,532 $ (5,731) $ 122,397
---------------- --------------- --------------- ---------------
Operating loss $ (7,620) $ (562) $ (51) $ (8,233)
---------------- --------------- --------------- ---------------
Identifiable assets $ 156,102 $ 3,945 $ (6,964) $ 153,083
---------------- --------------- --------------- ---------------
Operating expenses not directly related to a particular geographic segment
have been allocated between segments in proportion to net sales.
</TABLE>
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<PAGE>
15. SUBSEQUENT EVENT
The Company entered the spine instrumentation market in 1995 with the
introduction of the WRIGHTLOCK(TM) posterior fixation system and since then has
introduced its VERSALOK(TM) low back fixation system. On February 7, 1998,
executive management decided to actively pursue a buyer for the Company's spine
business as a whole including inventory, patents, trademarks, contracts and
licenses. The Company will continue to sell and further develop its current
products until an acceptable buyer can be found.
On March 11, 1998, the Company signed a Letter of Intent to sell its trauma
assets, patents, and agreements for $4 million, a Royalty Agreement, and 5% of
the voting common capital stock of the purchasing entity. Closing is expected to
be on or before June 15, 1998.
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<PAGE>
EXHIBIT INDEX
Does not include the documents incorporated by reference as delineated by
Item 14 of this Form 10-K.
10.26 Amended and Restated Joint Venture Agreement
with Tissue Engineering, Inc.
11.1 Statements re: Computation of Earnings per
Share
12.1 Statement re: Computation of Ratios of
Earnings to Fixed Charges and Preferred
Dividends
21.1 Subsidiaries of the Company
23.2 Consent of Arthur Andersen LLP
Page 96 of 119
AMENDED AND RESTATED
JOINT VENTURE AGREEMENT
THIS AMENDED AND RESTATED JOINT VENTURE AGREEMENT (the "Agreement") is
entered into as of the _____ day of August, 1997, by and between WRIGHT MEDICAL
TECHNOLOGY, INC., a Delaware corporation, having offices at 5677 Airline Road,
Arlington, Tennessee 38002 ("Wright") and TISSUE ENGINEERING, INC., a Delaware
corporation, having offices at The Fargo Building, 451 D Street, Boston,
Massachusetts 02210 (the "Company").
WHEREAS, the Company has developed and owns technology to produce
collagen-based scaffolds which can be used, among other things, for ligament and
tendon reconstruction, for cartilage regeneration, and for use with calcium
phosphate/sulfate as a bone graft substitute (collectively, the "Technology");
and
WHEREAS, Wright and the Company agreed, pursuant to a Joint Venture
Agreement dated July 12, 1996, (the "Original Agreement") to form a jointly
owned Delaware limited liability company (the "LLC") for the purpose of broadly
commercializing products for use in the treatment of musculoskeletal problems
based on the Technology (the "Products"); and
WHEREAS, the partners are entering into this Agreement to clarify and
correct certain ambiguities in the Original Agreement;
NOW, THEREFORE, in consideration of the premises and actual covenants set
forth herein and for other good and valuable consideration, the receipt and
sufficiency of which is hereby acknowledged, the parties hereby agree as
follows:
SECTION 1. AMENDMENT. The Original Agreement is hereby amended and restated
in its entirety by this Agreement.
SECTION 2. DEFINITIONS. The following definitions shall apply to this
Agreement:
"Additional Note" shall have the meaning given to it in Section 4(C)
hereof.
"Approved Marketing Expenses" for any period shall mean the total amount of
marketing expenses mutually agreed upon by Wright and the Company for such
period when Products become available for marketing (i.e., Food and Drug
Administration approval of the first Product). Within thirty (30) days following
the end of each Contract Year,
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<PAGE>
Wright shall provide the LLC with a written reconciliation of actual marketing
expenses and the Approved Marketing Expenses for such year. In the event the
actual marketing expenses do not exceed the Approved Marketing Expenses that had
been returned to Wright that year, the difference shall be added to Gross
Billings for the month in which the reconciliation is presented. Wright shall be
solely responsible for any actual marketing expenses that exceed the Approved
Marketing Expenses for any year.
"Approved R&D Expenses" for any period shall mean the total amount of
research and development expenses mutually agreed upon by Wright and the Company
for such period, either by separate agreement or as included in a Budget as
defined below. Within thirty (30) days following the end of each Contract Year,
the Company shall provide the LLC with a written reconciliation of actual
research and development expenses and the Approved R&D Expenses for such year.
In the event that the actual research and development expenses do not exceed the
Approved R&D Expenses that had been returned to the Company that year, such
difference shall be added to Gross Billings for the month in which the
reconciliation is presented. The Company shall be solely responsible for any
actual research and development expenses that exceed the Approved R&D Expenses
for any year, unless provision is made by the LLC for such research and
development Expenses and for other mutually agreed upon research and development
expenses to be paid by funds raised by the LLC.
"Budget" shall mean the annual budget of the LLC approved by Wright and the
Company, which shall include, among other things, budgets for sales forecasts,
Approved Marketing Expenses, Approved R&D Expenses, intellectual property
development, patent prosecution and maintenance expenses, pre-clinical and
clinical costs and expenses, administrative and accounting expenses; provided
that the initial budget for the LLC is attached hereto as Exhibit D.
"CGS" shall mean the Company's actual fully absorbed costs to manufacture
each Product sold.
"Commissions" shall mean the actual sales commissions to be paid by Wright
on the sale of the Products.
"Contract Year" shall mean each twelve month period commencing on January 1
and ending on December 31; provided that the first Contract Year shall commence
upon execution of this Agreement and end on December 31, 1996.
"Expenses" shall mean (1) Commissions; provided, however, that in any one
month period those Commissions may not exceed twenty percent
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<PAGE>
(20%) of the Gross Billings; (2) the CGS; (3) Approved Marketing Expenses;
provided, however, that such marketing expenses shall cease to be deducted when
the aggregate Approved Marketing Expenses for a given year have been repaid to
Wright; (4) Wright's shipping costs for Products sold if such costs are able to
be billed by Wright to the customer and if not otherwise included in CGS; (5)
Approved R&D Expenses, manufacturing scale-up and manufacturing expenses
incurred by the Company; (6) all costs and expenses of Wright associated with
pre-clinical animal studies and clinical studies; and (7) any other expenses
that Wright and the Company agree to deduct.
"Field" shall mean the field of musculoskeletal applications, excluding
dental applications.
"Formation Date" shall have the meaning given to it in Section 4(A) hereof.
"Gross Billings" shall mean the sum of (1) the gross sales price charged by
Wright, (2) excess Approved Marketing Expenses and (3) excess Approved R&D
Expenses.
"Initial Note" shall have the meaning given to it in Section 4(B)(1)
hereof.
"License" shall mean the royalty free, exclusive and perpetual license
granted by the Company for the Technology for use in the musculoskeletal field,
excluding dental applications, to the LLC pursuant to a license agreement
substantially in the form of Exhibit A attached hereto.
"Net Profit" for any period shall mean the aggregate Gross Billings minus
Expenses.
"Proprietary Information" shall mean any information of either party or the
LLC that might reasonably be considered proprietary, secret, sensitive or
private, including but not limited to: (a) technical information, know-how,
data, techniques, discoveries, inventions, ideas, unpublished patent
applications, trade secrets, formulae, analyses, laboratory reports, other
reports, financial information, studies, findings, or other information relating
to the LLC or the Technology or methods or techniques used by the LLC, whether
or not contained in samples, documents, sketches, photographs, drawings, lists
and the like; (b) data and other information employed in connection with the
marketing of the Products, including cost information, business policies and
procedures, revenues and markets, distributors and customers, and similar items
of information whether or not contained in documents or other tangible
materials; or (c) any
Page 99 of 119
<PAGE>
other information obtained by any party to this Agreement during the term
hereof, that is not generally known to, and not readily ascertainable by proper
means by, third parties.
SECTION 3. PURPOSE OF THE LLC. The LLC will be established for the purpose
of commercializing products in the Field based on the Technology. It is expected
that the LLC initially will focus a large share of its efforts toward products
that can be manufactured using the Technology and commercialized in the near
future. It is also expected that an appropriate balance of longer term product
opportunities will be maintained, working to develop commercializable products.
The parties hereto agree to negotiate in good faith to enter into one or more
additional LLC agreements in the event transactions contemplated by this
Agreement result in additional product ideas.
SECTION 4. FORMATION OF LLC; FURTHER CAPITAL CONTRIBUTIONS;
ADDITIONAL AGREEMENTS OF THE PARTIES.
A. As soon as practicable following the execution of this Agreement, the
parties hereto shall cause the LLC to be formed as a limited liability company
pursuant to the laws of the State of Delaware by entering into a Limited
Liability Company Agreement (the "Charter"). The date of such filing is
hereinafter referred to as the "Formation Date". To the extent that there is any
conflict between the terms of the Charter and the terms of this Agreement, the
terms of this Agreement shall control.
B. On the Formation Date:
1. Wright shall contribute to the LLC (a) initial administrative,
accounting and legal support in order to create the LLC and (b) a promissory
note in the amount of $1,500,000 (the "Initial Note"), which Initial Note shall
be drawn down on demand by the LLC in accordance with the Budget, in exchange
for issuance by the LLC on the Formation Date of 49% of the validly issued,
fully paid and nonassessable shares of capital stock of the LLC issued and
outstanding on the Formation Date.
2. The Company shall contribute to the LLC the License to the Technology in
exchange for issuance by the LLC on the Formation Date of 51% of the validly
issued, fully paid and nonassessable shares of capital stock of the LLC issued
and outstanding on the Formation Date.
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<PAGE>
3. Wright and the Company shall execute an interest holders agreement
substantially in the form of Exhibit B attached hereto.
C. Wright hereby agrees to make additional funding contributions to the
LLC, in furtherance of the LLC, in the amount of $1,500,000 on each of the first
and second annual anniversary of the Formation Date; provided that each such
obligation shall be satisfied by delivering to the LLC a promissory note in the
amount of $1,500,000 (the "Additional Note"). To the extent that the LLC is able
to raise its own capital, or arrange for its own financing, Wright shall be able
to charge the LLC reasonable fees reflecting its fully absorbed cost for
providing administrative, accounting, legal, regulatory and clinical support
provided to the LLC and, in addition to the research and development provided
pursuant to the Budget for the first three years, beginning on the four year
anniversary of the execution of this Agreement, the Company shall be able to
charge the LLC for research and development support and support of product
manufacturing at normal commercial rates for such services.
D. The Company hereby agrees to grant to Wright an irrevocable voting proxy
for that number of shares of capital stock of the LLC equal to 1% of the issued
and outstanding stock of the LLC on the Formation Date, it being the intent of
the parties hereto that the Company and Wright each have a right to vote 50% of
the issued and outstanding stock of the LLC at all times; provided, however,
that in the event that Wright is a party to any agreement that prohibits it from
exercising such voting proxy, such proxy shall be granted to an independent
third party mutually acceptable to both Wright and the Company; and provided,
further, that Wright shall have the option to purchase such 1% interest for
$1.00 at anytime following the Formation Date. Furthermore, the Company hereby
agrees to take all action necessary to ensure that any such proxy continues in
perpetuity, including without limitation, executing subsequent voting proxy upon
the expiration of any existing proxy under applicable Delaware law or, at the
request of Wright, entering into a voting trust to effectuate the purposes set
forth in this Section 4(D).
SECTION 5. CORPORATE GOVERNANCE; MANAGEMENT.
A. Except as otherwise required by law or as provided in the Charter,
responsibility for the management, direction and control of the LLC shall be
vested in the managers of the LLC. The Charter shall provide for the election of
four managers.
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<PAGE>
B. The managers of the LLC shall be elected annually at annual meetings of
the members of the LLC. It is understood and agreed by the parties hereto that
two of the managers of the LLC shall be individuals nominated by Wright and two
of the managers of the LLC shall be individuals nominated by the Company. Each
of the parties hereto covenants and agrees to vote its shares of stock of the
LLC to cause the election of the managers nominated in accordance with the
foregoing. In the event of the death, incapacity, resignation or removal of a
manager prior to the end of his or her term, each of the parties hereto agrees
to vote its shares of stock so as to appoint as his or her replacement a manager
nominated by the party hereto who nominated the manager whose death, incapacity,
resignation or removal was the cause of such vacancy.
C. Wright and the Company shall take all actions necessary or appropriate
to ensure that the Charter accurately reflects the arrangements set forth in
this Section 5.
D. The management of the LLC shall be comprised of officers designated by
the managers of the LLC. Each of the parties hereto hereby covenants and agrees
to cause the managers of the LLC nominated by it to cast their votes so as to
appoint as officers of the LLC individuals who qualify under the foregoing
provisions of this Section 5(D). In the event of death, incapacity, resignation
or other removal of an officer prior to the end of his or her term, each of the
parties hereto agrees to cause the directors of the LLC to cast their votes so
as to appoint his or her replacement a nominee who qualifies under said
foregoing provisions of this Section 5(D).
E. Notwithstanding anything to the contrary contained herein, the parties
hereto hereby agree to use their best efforts to avoid the occurrence of any
deadlock and further agree to use their best efforts to resolve any deadlock as
expeditiously as possible.
F. The parties hereto agree that the managers of the LLC shall meet at
least once each calendar quarter at such time and place acceptable to all
managers, and at each annual meeting of the managers, an annual operating Budget
of the LLC shall be adopted.
G. If the parties are unable to agree at any managers' meeting to act upon
a resolution approving the LLC's annual operating plan and Budget, the parties
hereto agree that a top-level meeting be convened between the parties, attended
by corporate officers of each party with decision-making authority regarding the
dispute, in order to attempt in good faith to resolve the matter. At such
meeting each of the parties hereto will use its best efforts to resolve the
deadlock and such meeting shall continue until a resolution is achieved.
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<PAGE>
SECTION 6. RESEARCH AND DEVELOPMENT ACTIVITIES.
A. Wright will use its best efforts to obtain regulatory approval to sell
and distribute the Products. In connection therewith, Wright and the Company
will meet, discuss and formulate a plan for Wright to fund pre-clinical animal
studies and clinical trials to be conducted by the LLC, which funding shall be
reimbursed pursuant to Section 4(c) hereof. Wright and the Company agree to
establish a clinical trials committee (the "CTC"), comprised equally of members
from Wright and the Company. The CTC will design and supervise the clinical
trials and shall have the full authority to direct the conduct of such clinical
trials. The CTC will operate by consensus, however, in the event the members of
the CTC cannot unanimously agree upon any given matter (other than matters
related to the funding of the clinical trials), such matter shall be referred to
and resolved by an oversight committee comprised of an equal number of
independent members from the respective scientific advisory boards of Wright and
the Company.
B. Wright agrees that it shall use commercially reasonable efforts to
assist and consult with the LLC with respect to financial, accounting,
regulatory, engineering and manufacturing matters relating to the Products.
C. The LLC shall use the Company exclusively for research and development
services. In providing such services, the Company shall retain employees and
consultants and purchase such equipment and supplies in accordance with the
Budget and for its own account. The Company shall be reimbursed for such
expenditures, as well as for overhead and other expenditures set forth in the
Budget, in accordance with the Budget. In the event the Company ceases to
provide such research and development services, the LLC shall be permitted to
find alternatives sources of research and development services.
D. (1) After the fourth anniversary of this Agreement, the Company shall
provide research and development services to the LLC and (2) upon commencement
of production of any Products, the Company shall provide manufacturing services,
each on financial terms to be mutually agreed upon by the Company, the LLC and
Wright.
SECTION 7. DISTRIBUTION RIGHTS; INTELLECTUAL PROPERTY
RIGHTS.
A. In furtherance of the LLC, the Company hereby agrees to cause the LLC to
grant and convey to Wright the world-wide exclusive rights to sell, market,
distribute and conduct all incidental and necessary activities thereto with
respect to the Products pursuant to
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<PAGE>
a distribution agreement substantially in the form of Exhibit C attached hereto.
B. The Company shall own all patents associated with the Technology;
provided that the Company hereby grants the LLC a royalty-free license to the
Company's intellectual property to the extent necessary to make, use and sell
any Product, including without limitation, any and all patents and registered
trademarks, which license shall be exclusive for musculoskeletal use. Such
license shall automatically transfer to any successors in interest of the LLC.
Wright shall have the right to develop and own trademarks and tradenames for the
sale of the Product; provided that Wright shall undertake to acknowledge in any
Product literature that the Company participated in the invention of such
Product. Any intellectual property developed by either party, or by any third
party, pursuant to work commissioned as an Approved R&D Expense shall be owned
by the LLC. Patent prosecution and maintenance costs associated with such
intellectual property shall be paid by the LLC. Research and development
conducted by either party, independent of this Agreement, or not commissioned as
an Approved R&D Expense, and the intellectual property associated therewith,
shall be owned by the party conducting such research and development.
SECTION 8. PROFIT SHARING; SALES; FORECASTS, ETC.
A. Profit Sharing. The LLC shall pay each of Wright and the Company fifty
percent (50%) of all Net Profits, if any, on the sale of any Products during
each month; provided that, if in any month Expenses exceed Gross Billings, such
excess Expenses shall be carried forward and deducted in the following month on
a pro rata basis consistent with the percentage of Expenses incurred and paid
that month to Wright and the Company respectively. The Net Profit calculation
shall be conducted by Wright, and the LLC shall tender any payment to the
Company and Wright, or in the case of Wright, reduce the Initial Note or
Additional Notes, within 90 days of the end of each month.
B. Sales. Wright hereby agrees to use commercially reasonable efforts to
promote the Products in accordance with the Budgets.
C. Forecasts. Wright shall provide quarterly sales forecasts that will
include its best forecast for sales in the succeeding three (3) months as well
as projected sales for the succeeding twelve (12) months.
D. Orders and Receivables. Wright shall take all orders for the Products.
Upon notification from Wright, the Company shall be
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<PAGE>
responsible for promptly delivering such Products directly to the customer or
Wright, as directed by Wright from time to time. The Company shall provide the
Product packaged and sterile according to Wright's packaging instructions.
Wright shall be responsible for all billing and collections. Freight shall be
shipped F.O.B. the Company and shall be added by Wright to all billings to
customers, if acceptable to the marketplace.
SECTION 9. ACCOUNTING AND GENERAL REPORTING.
A. The accounting period of the LLC shall commence on January 1 of each
year end on December 31 of the following; provided that the first accounting
period of the LLC shall commence as of the date this Agreement is executed and
end on the next following December 31.
B. Wright shall be responsible for keeping all books and records of the LLC
in accordance with sound and generally accepted accounting principles applicable
to the LLC and corporate practices consistently applied. Wright shall make and
keep books, records and accounts that in reasonable detail accurately and fairly
reflect the transactions of the LLC.
C. Wright shall prepare monthly, quarterly and annual financial statements
of the LLC. Such financial statements shall be prepared in accordance with
generally accepted accounting principles. Wright shall submit such statements to
the Company as soon as practicable (but not later than 45 days in the case of
monthly and quarterly financial statements and 90 days in the case of annual
financial statements) after the end of each period.
D. Each party shall have the right, upon 10 days notice, to inspect the
financial records of the other party and the LLC only as they relate to the
calculation of Expenses (including without limitation, commissions, Approved
Marketing Expenses and Approved R&D Expenses), Gross Billings and the
calculation of Net Profit. All materials reviewed and all materials prepared by
the other party based upon the audit shall remain confidential and not be used
for any purpose other the operation or enforcement of this Agreement.
SECTION 10. PROPRIETARY INFORMATION.
A. All business, technical, research and development and financial
information and materials containing such business information provided by the
parties to each other, including without limitation, lists of present or
prospective customers or vendors or of persons that have or shall have dealt
with the respective parties hereto, customer requirements, preferences and
methods of operation,
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<PAGE>
management information reports and other computer generated reports, pricing
policies and details, details of contracts, operational methods, plans or
strategies, business acquisition plans, new personnel acquisition plans,
product information and samples, technology, know-how, patent applications,
designs and other business, technical, research and development and financial
affairs learned heretofore or hereafter, are and shall be treated as
confidential. Each party agrees for itself and on behalf of its directors,
officers, employees and agents to whom such information and materials are
disclosed, that it and they shall keep such information and materials
confidential and retain them in strictest confidence both during and after the
term of this Agreement. Such information and materials shall not be disclosed by
either party to any person except to its officers and employees requiring such
information or materials to perform services pursuant to this Agreement and
except to other persons under a confidentiality agreement with either party
protecting such information from disclosure. Each party acknowledges and agrees
that it shall be liable to the other for damages caused by any breach of this
provision or by any unauthorized disclosure or use of such confidential
information and materials by its officers and employees or third parties to whom
unauthorized disclosure was made. In addition to any other rights or remedies
that may be available to each party, each party shall be entitled to appropriate
injunctive relief or specific performance against the other or its officers and
employees to prevent unauthorized disclosure of such confidential information
and materials or other breach of this provision. Each party acknowledges and
agrees that such unauthorized disclosure or other breach of this provision will
cause irreparable injury to the other party and that money damages will not
provide an adequate remedy. Each party shall be entitled to recover from the
other its costs, expenses and attorneys' fees incurred in enforcing its rights
under this Section 9. Each party shall return to the other all such information
and materials covered under this Section 9 and received pursuant to this
Agreement and all copies thereof immediately upon the termination of this
Agreement.
B. This obligation of confidentiality shall not apply to any information
that (1) was known to the receiving party at the time of receipt as evidenced by
tangible records; (2) was in the public domain at the time of receipt; (3)
becomes publicly available through no fault of the party obligated to keep it
confidential; (4) such party legitimately learns from third parties who are
under no obligation of confidentiality with respect to the information; or (5)
is required by applicable law or court order or other mandatory legal process to
be disclosed.
Page 106 of 119
<PAGE>
C. The provisions of this Section 10 shall survive the termination or
expiration of this Agreement.
SECTION 11. OPERATION OF THE LLC.
A. The Company shall provide the LLC with product research and development
services, engineering support, patent services, as well as manufacture the
Products for sale by the LLC, all pursuant to the Budget of Approved R&D
Expenses. As set forth in the Budget, the Company hereby agrees to provide
continuing research and development support necessary to meet customer demand,
technological advances and as may reasonably be requested by the LLC or Wright,
and employees of the Company shall be regularly available to consult and work
with the LLC and Wright on such research and development. In addition, the
Company shall manufacture and supply all Products necessary for the conduct of
the LLC's business; provided that the LLC may use an alternative manufacturer or
supplier that it determines is more cost effective than the Company. In order to
receive the necessary funding for the conduct of all Approved R&D Expenses and
all other Expenses set forth in the Budget, the LLC shall be allowed to draw
down upon the Initial Note on the first of each month an advance of $100,000, to
be used to fund Approved R&D Expenses of the LLC. Within seven days following
the end of each calendar month, the Company shall provide a reconciliation of
the previous month's Approved R&D Expenses. This advance shall be transferred by
wire directly to a segregated non-commingle operating account of the Company by
the 1st of the month. If during any month the reconciliation reflects a credit
balance in excess of $10,000, or if a large purchase is anticipated exceeding
$10,000, this monthly advance amount may be adjusted accordingly by mutual
agreement between Wright and the Company.
B. Wright shall provide the LLC with administrative services, accounting
services and marketing service, all pursuant to the Budget of Approved Marketing
Expenses. In addition, Wright shall be fully responsible for any and all
regulatory approvals necessary for the public sale and marketing of the Product
and all labeling and warnings associated with the Product. The Company promptly
shall provide Wright notice of any and all claims from third parties regarding
any of the Products, including events that may be reportable as an under any
current or future Food and Drug Administration MDR (medical device reporting)
regulations. Upon request, Wright shall consult with the Company regarding,
and/or provide the Company with proof of any regulatory approvals. In order for
Wright and the Company to be reimbursed for expenses detailed in Section 3(C)
hereof, and for those Approved Marketing Expenses and all other Expenses set
forth in the Budget, Wright and the Company shall provide the LLC with monthly
invoices, which invoices shall set forth in reasonable detail the
Page 107 of 119
<PAGE>
services provided and which shall be paid within 15 days of receipt by the LLC.
C. Wright shall be the exclusive distributor of all Products, and shall be
entitled to distribute the Products in a manner consistent with the
distribution of its own products.
D. The LLC shall be managed in accordance with its Budget and detailed
business plans. In accordance with the initial Budget, the LLC shall be
permitted to draw down the Initial Note upon demand in amounts equal to
approximately $800,000 for direct expenses and approximately $700,000 for
indirect expenses. In addition, the LLC shall be permitted to draw down upon
each Additional Note in amounts necessary to fund operations.
SECTION 12. COVENANTS OF THE PARTIES.
A. Except as otherwise expressly provided herein, all costs and expenses
incurred in connection with the preparation and execution of this Agreement and
the transactions contemplated hereby, including without limitation, attorneys'
fees and advisors' fees, if any, will be paid by the party incurring such costs
and expenses.
B. Each of the parties hereby agree to use all reasonable efforts to take,
or cause to be taken, all actions and to do, or cause to be done, all things
necessary, proper or advisable under applicable laws, rules and regulations to
consummate and make effective the transactions contemplated by this Agreement,
including without limitation, any state or federal regulatory filings. In the
event that at any time after the execution of this Agreement, further action is
necessary or desirable to carry out the purposes of this Agreement, the proper
officers or directors of each of the parties shall take such necessary action.
C. Upon execution of this Agreement, and continuing during its term, the
Company shall provide the LLC access to, or copies of, all documents and things
in the Company's control which relate to the Products and are necessary for the
LLC to conduct its business, including without limitation, obtaining regulatory
approval for any Product.
D. The Company hereby agrees to use its reasonable efforts during the term
of this Agreement to actively seek to develop the Products and to make prudent
and efficient use of the Initial Note and Additional Note, as well as its own
research and development expenditures. As used in this Agreement, the term
"best efforts" shall mean the commercially reasonable efforts that a prudent
person desiring to
Page 108 of 119
<PAGE>
achieve a particular result would use in order to ensure that such result is
achieved as expeditiously as possible.
E. Each of the parties hereto hereby agrees to at all times conduct its
efforts hereunder in strict compliance with all applicable federal, state and
local laws and regulations and with the highest government standards.
F. Each of the parties hereto hereby agrees to use its best efforts to
arrange for independent financing for the LLC; provided, that in the event that
the LLC obtains such independent financing, the parties hereto hereby agree to
cause the LLC to distribute the first $1,000,000 of any such proceeds to Wright
as a return of its Initial Note.
SECTION 13. LIABILITY.
A. The Company shall indemnify and hold harmless Wright from all liability,
damages, costs and expenses (including reasonable attorneys' fees) incurred as a
result of any claims, actions, judgments and demands for injuries to persons or
property arising from any and all design or manufacturing defects in the
Products (collectively, a "Claim"), and for any conduct of the Company, but not
for claims, actions, judgments, and demands arising from Wright's negligence,
gross negligence, or willful misconduct with respect to the sale and
distribution of Products.
B. Wright shall indemnify and hold harmless the Company from any Claim
arising from Wright's negligence, gross negligence, or willful misconduct with
respect to the sale and distribution of Products.
C. The provisions of paragraphs 13(A) and 13(B) hereof shall survive the
expiration and any termination of this Agreement.
D. Upon commercialization of Products, the LLC shall carry liability
insurance regarding the Products in an amount consistent with industry practice,
and each of the Company and Wright shall carry commercially reasonable amounts
of insurance commensurate with their respective obligations under this Agreement
(including without limitation, its indemnification obligations) and support of
the LLC's operations.
E. With respect to any actual or potential Claim or demand or commencement
of any action, or the occurrence of any other event, relating to any Claim
against which a party hereto is indemnified (the
Page 109 of 119
<PAGE>
"Indemnified Party") by the other party (the "Indemnifying Party") under this
Section 13:
1. Promptly after the Indemnified Party first receives written documents
pertaining to the Claim, or if such Claim does not involve a third party Claim
(a "Third Party Claim"), promptly after the Indemnified Party first has actual
knowledge of such Claim, the Indemnified Party shall give notice to the
Indemnifying Party of such Claim in reasonable detail, stating the amount
involved, if known, together with copies of any such written documentation.
2. The Indemnifying Party shall have no obligation to indemnify the
Indemnified Party with respect to any Claim if the Indemnified Party fails to
give the notice with respect thereto in accordance with this Section 13.
3. If the Claim involves a Third Party Claim, then the Indemnifying Party
shall have the right, at its sole cost, expense and ultimate liability
regardless of the outcome, and through counsel of its choice (which counsel
shall be reasonably satisfactory to the Indemnified Party), to litigate, defend,
settle or otherwise attempt to resolve such Third Party Claim; provided,
however, that if in the Indemnified Party's reasonable judgment a conflict of
interest may exist between the Indemnified Party and the Indemnifying Party with
respect to such Third Party Claim, then the Indemnified Party shall be entitled
to select counsel of its own choosing, reasonably satisfactory to the
Indemnifying Party, in which event the Indemnifying Party shall be obligated to
pay the reasonable fees and expenses of such counsel. Notwithstanding the
preceding sentence, the Indemnified Party may elect, at any time and at the
Indemnified Party's sole cost, expense and ultimate liability, regardless of the
outcome, and through counsel of its choice, to litigate, defend, settle or
otherwise attempt to resolve such Third Party Claim. If the Indemnified Party so
elects (for reasons other than the Indemnifying Party's failure or refusal to
provide a defense to such Third Party Claim), then the Indemnifying Party shall
have no obligation to indemnify the Indemnified Party with respect to such
Third Party Claim, but such disposition will be without prejudice to any other
right the Indemnified Party may have to indemnification under this Section 13,
regardless of the outcome of such Third Party Claim. If the Indemnifying Party
fails or refuses to provide a defense to any Third Party Claim, then the
Indemnified Party shall have the right to undertake the defense, compromise or
settlement of such Third Party Claim, through counsel of its choice, on behalf
of and for the account and at the risk of the Indemnifying Party, and the
Indemnifying Party shall be obligated to pay the costs, expenses and reasonable
attorneys' fees incurred by the Indemnified Party in connection with such Third
Party Claim. In any
Page 110 of 119
<PAGE>
event, Wright and the Company shall fully cooperate with each other and their
respective counsel in connection with any such litigation, defense, settlement
or other attempted resolution.
SECTION 14. TERM AND TERMINATION.
A. The term of the Agreement shall commence as of the date of execution of
this Agreement and unless this agreement is terminated earlier pursuant to the
provisions hereof or otherwise, shall expire upon dissolution of the LLC. During
the term that this Agreement remains in effect, the Company and Wright agree not
to sell or distribute any other product line similar to the Products for use in
the Field without the consent of the other party; provided, however, that this
restriction shall not apply to any product line incidentally acquired by either
company through the purchase of another entity and subsequently contributed to
the LLC, Wright's ownership interest in OsteoBiologics, Inc. or the sale or
distribution by Wright of products developed by OsteoBiologics, Inc.
B. In addition to other events of termination set forth in this Agreement,
this Agreement shall terminate in the following events:
1. If either party breaches a material term or provision of this Agreement
and the breaching party fails to cure the breach within 180 days after notice
thereof, the non-breaching party may terminate this Agreement, with such
termination effective upon expiration of the 180 day period.
2. If any governmental authority limits the ability of the LLC or the
Company to manufacture or the LLC or Wright to sell the Products in any material
respect, either party may terminate this Agreement by giving written notice of
termination for such reason to the other party, such termination to be effective
upon the giving of such notice.
C. Upon the expiration or termination of this Agreement, Wright shall have
no right to order or purchase Products from the Company or the LLC, but may
dispose of its inventory of the Products through normal channels. Upon the
termination of this Agreement, all intellectual property owned by either party,
but licensed to the LLC, shall, subject to the terms of any applicable license
agreement, remain property of the respective party.
SECTION 15. MISCELLANEOUS.
A. Should any provision of this Agreement be determined by a
Page 111 of 119
<PAGE>
court having jurisdiction over the parties and the subject matter to be illegal
or unenforceable in such jurisdiction, the parties agree that such determination
shall not affect or impair the validity or enforceability of such provision in
any other jurisdiction or the validity or enforceability of any other provision.
The determination by a court having jurisdiction over the parties and the
subject matter that any provision of this Agreement is illegal or unenforceable
in such jurisdiction shall also not affect the validity or enforceability of the
other provisions of the Agreement in that jurisdiction.
B. If a claim for indemnification arises under this Agreement, the
Indemnified Party shall give the Indemnifying Party prompt written notice of any
event which might give rise to a claim for indemnification, specifying the
nature of the possible claim and the amount believed to be involved. If the
claim for indemnification arises from a claim or dispute with any third person,
the Indemnifying Party shall have the right, at its own expense, to defend
and/or settle such claim or dispute, and the Indemnified Party shall generally
cooperate fully in any such defense, but at no out-of-pocket cost to the
Indemnified Party.
C. In the event that either party is unable to carry out its obligations
under this Agreement due to force majeure (including, without limitation, acts
of God; war; riot; fire; flood; explosion; labor disputes; embargoes; or
unavailability or shortages of raw materials, bulk, equipment or transport), the
failure so to perform shall be excused and not constitute a default hereunder
during the continuation of the intervention of such force majeure. The party
affected by such force majeure shall resume performance as promptly as
practicable after such force majeure has been eliminated. Notwith standing the
foregoing, in the event either party is unable to carry out its obligations
hereunder by reason of such force majeure for a period of 180 days or more, than
either party may at any time thereafter during the continuation of such force
majeure terminate this Agreement upon notice to the other party setting forth
the circumstances of such force majeure.
D. This Agreement is binding upon and inures to the benefit of the parties
hereto and their respective permitted successors and assigns.
E. This Agreement, including the Exhibits annexed hereto, constitutes the
entire agreement between the parties with reference to the subject matter hereof
and supersedes all previous agreements, representations, memoranda and
undertakings whether verbal or written, between the parties with respect to the
subject matter hereof and may not be changed without the written consent of the
parties.
Page 112 of 119
<PAGE>
F. Except as provided for in Section 5(G), any disputes regarding this
Agreement between the parties shall be settled by binding arbitration under the
rules of the American Arbitration Association. Each party shall pick a single
temporary arbitrator which two arbitrators will then choose the single
arbitrator before whom the dispute shall be heard. The dispute shall be heard
before that single arbitrator in Memphis, Tennessee, if initiated by the
Company and in Boston, Massachusetts, if initiated by Wright.
G. All notices and reports required or permitted to be given under this
Agreement shall be deemed validly given and made if in writing and delivered
personally (as of such delivery) or sent by registered or certified mail,
postage prepaid, return receipt re quested (as of ten (10) days after deposit in
the mail) or sent by facsimile or overnight courier service, charges prepaid (as
of the date of confirmed receipt) to the party to be notified in care of its
General Counsel at its address (or facsimile number if sent by facsimile) first
set forth above. Either party may, by notice to the other, change its address
and facsimile number for receiving such notices or reports.
H. This Agreement shall be construed in accordance with and governed by the
laws of Tennessee without regard to its principles of conflicts of laws.
I. Nothing contained in this Agreement shall be deemed to constitute either
party as the agent for the other, or to establish a fiduciary relationship of
any kind between the parties.
Page 113 of 119
<PAGE>
IN WITNESS WHEREOF, the parties hereto have executed and delivered this
Agreement as of the day and year first above written.
WRIGHT MEDICAL TECHNOLOGY, INC.
By: /s/Lewis H. Ferguson, III
Name: Lewis H. Ferguson
Title: Senior Vice President
TISSUE ENGINEERING, INC.
By: /s/Eugene Bell
Name: Eugene Bell
Title: CEO & President
Page 114 of 119
<TABLE>
WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE
(in thousands, except loss per share)
Years Ended
-------------------------------------------------------------
December 31, 1997 December 31, 1996 December 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
Net loss $ (22,572) $ (14,589) $ (6,492)
Dividends on preferred stock (12,121) (14,251) (10,455)
Accretion of preferred stock discount (6,477) (6,458) (2,836)
----------------- ----------------- ------------------
Net loss applicable to common
and common equivalent shares $ (41,170) $ (35,298) $ (19,783)
================= ================= ==================
Weighted average shares of
common stock outstanding (a) 9,397 9,059 8,825
================= ================= ==================
Loss per share of common stock $ (4.38) $ (3.90) $ (2.24)
================= ================= ==================
<FN>
(a) During 1997, the Company adopted Statement of Financial Accounting
Standards No. 128, "Earnings per Share". Because of the net loss
applicable to common stock, diluted weighted average shares of common
stock outstanding has not been computed as the effect of the assumed
exercise of common stock equivalents would be anti-dilutive.
</FN>
</TABLE>
Page 115 of 119
<TABLE>
WRIGHT MEDICAL TECHNOLOGY, INC. AND SUBSIDIARIES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES AND PREFERRED DIVIDENDS
(in thousands, except ratios)
<CAPTION>
Years Ended December 31,
---------------------------------------------------------
1997 1996 1995
----------------- ----------------- -----------------
Earnings:
<S> <C> <C> <C>
Loss before income taxes $ (22,572) $ (14,589) $ (4,873)
Add back: Interest expense 11,675 10,718 10,899
Amortization of debt issuance cost 1,387 1,361 1,036
Portion of rent expense representative of interest factor 519 459 451
----------------- ----------------- -----------------
Earnings (loss) as adjusted $ (8,991) $ (2,051) $ 7,513
================= ================= =================
Fixed charges:
Interest expense $ 11,675 $ 10,718 $ 10,899
Amortization of debt issuance cost 1,387 1,361 1,036
Portion of rent expense representative of interest factor 519 459 451
----------------- ----------------- -----------------
$ 13,581 $ 12,538 $ 12,386
================= ================= =================
Preferred dividends $ 12,121 $ 14,251 $ 16,863
Accretion of preferred stock 6,477 6,458 4,573
----------------- ----------------- -----------------
$ 18,598 $ 20,709 $ 21,436
================= ================= =================
Ratio of earnings to fixed charges (a) (a) (a)
================= ================== =================
Ratio of earnings to fixed charges, preferred dividends and accretion
of preferred stock (b) (b) (b)
================= ================== =================
<FN>
(a) Earnings were inadequate to cover fixed charges by $22.6 million, $14.6
million, and $4.9 million, respectively, for the years ended December 31,
1997, December 31, 1996, and December 31, 1995.
(b) Earnings were inadequate to cover fixed charges, preferred dividends and
accretion of preferred stock by $41.2 million, $35.3 million, and $26.3
million respectively, for the years ended December 31, 1997, December 31,
1996, and December 31, 1995. Certain of the preferred dividends are, at
the option of the Company, payable in kind.
</FN>
Page 116 of 119
</TABLE>
SUBSIDIARIES OF THE COMPANY
- Wright Medical Technology Canada Ltd.
- OrthoTechnique, S.A.
Page 117 of 119
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the
incorporation of our report included in this Form 10-K, into the Company's
previously filed Form S-8 Registration Statements File Nos.
33-73232 and 33-73230.
Memphis, Tennessee,
March 25, 1998
Page 118 of 119
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Consolidated Financial Statements and is qualified in its entirety by reference
to such financial statements.
</LEGEND>
<MULTIPLIER> 1000
<CURRENCY> U.S. dollars
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 466
<SECURITIES> 0
<RECEIVABLES> 19,784
<ALLOWANCES> 744
<INVENTORY> 58,890
<CURRENT-ASSETS> 82,145
<PP&E> 63,172
<DEPRECIATION> 36,440
<TOTAL-ASSETS> 153,083
<CURRENT-LIABILITIES> 41,779
<BONDS> 84,591
9
0
<COMMON> 11
<OTHER-SE> (96,990)
<TOTAL-LIABILITY-AND-EQUITY> 153,083
<SALES> 122,397
<TOTAL-REVENUES> 122,397
<CGS> 46,687
<TOTAL-COSTS> 46,687
<OTHER-EXPENSES> 85,220
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 13,062
<INCOME-PRETAX> (22,572)
<INCOME-TAX> 0
<INCOME-CONTINUING> (22,572)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (22,572)
<EPS-PRIMARY> (4.38)
<EPS-DILUTED> (4.38)
</TABLE>
