(1) 2011 adjusted results presented above exclude $9.1 million ($6.2 million after tax eff ect) of non-cash stock-based compensation expense. The 2011 adjusted results pre-
sented above also exclude $12.9 million ($7.8 million after tax eff ect) of charges related to our Deferred Prosecution Agreement, $4.1 million ($2.5 million after tax) of transaction
costs and non-cash deferred fi nancing fees associated with the 2.625% Convertible Senior Notes tender off er, $16.9 million ($10.7 million after tax) of restructuring charges as-
sociated with our cost restructuring plan, $2.0 million ($1.3 million after tax) of expenses associated with settlement of certain employment matters and the hiring of a new chief
executive offi cer, $13.2 million ($8.5 million after tax) related for management’s estimate of our total liability for claims associated with previous and estimated future fractures of
our titanium PROFEMUR® long neck in North America, $32,000 ($20,000 after tax eff ect) of non-cash inventory step-up amortization. In addition, the 2011 adjusted net income
results exclude a $1.0 million tax provision to record an estimated IRS audit liability.
(2) 2010 adjusted results presented above exclude $13.2 million ($8.8 million after tax eff ect) of non-cash stock-based compensation expense. The 2010 adjusted results pre-
sented above also exclude $10.9 million ($8.6 million after tax eff ect) of charges related to our U.S. government inquiries and our independent monitor, and $919,000 ($543,000
after tax eff ect) of restructuring charges associated with the closure of our Toulon, France operations and Creteil, France operations.
(3) 2009 adjusted results presented above exclude $13.2 million ($9.3 million after tax eff ect) of non-cash stock-based compensation expense. The 2009 adjusted results
presented above also exclude $7.8 million ($5.1 million after tax eff ect) of charges related to our U.S. government inquiries, $3.5 million ($275,000 after tax eff ect) of restructuring
charges associated with the closure of our Toulon, France operations and Creteil, France operations, $2.6 million write off of the cumulative translation adjustment balances from
certain subsidiaries following the substantially complete liquidation of these entities, $5.6 million ($3.8 million after tax eff ect) provision recorded in 2009 for potential losses
related to the trade receivable balance of our stocking distributor in Turkey, and $70,000 ($43,000 after tax eff ect) of acquisition-related inventory step-up amortization.
(4) 2008 adjusted results presented above exclude $13.5 million ($9.8 million after tax eff ect) of non-cash stock-based compensation expense, $11.2 million tax provision associ-
ated with the write-off of net operating losses in France, $7.6 million ($4.7 million after tax eff ect) of charges related to our U.S. government inquiries, $6.7 million ($3.3 million af-
ter tax eff ect) of restructuring charges associated with the closure of our Toulon, France operations, $2.6 million ($1.6 million after tax eff ect) for charges relating to an unfavorable
appellate court decision (including interest), $2.5 million of acquired in-process research and development costs, and $113,000 ($69,000 after tax eff ect) of acquisition-related
inventory step-up amortization.
(5) 2007 adjusted results presented above exclude $16.5 million ($12.9 million after tax eff ect) of non-cash stock-based compensation expense, $18.9 million ($12.5 million after
tax eff ect) of restructuring charges associated with the closure of our Toulon, France operations, $3.9 million ($2.4 million after tax eff ect) of charges related to an unfavorable
arbitration ruling (including interest), and $418,000 ($253,000 after tax eff ect) of acquisition-related inventory step-up amortization.
2011 Annual Report Wright Medical Group, Inc. 1
“ ... I believe we have the elements in place to achieve
greater success than we have ever experienced before ...
Robert J. Palmisano, President and Chief Executive Offi cer
To our valued stockholders, customers,
and employees
Since joining Wright Medical late last year, I have been impressed
not only by our products, but also by the talent, perseverance,
and willingness for hard work of its people. I believe we have the
elements in place to achieve greater success than we have ever
experienced before.
Let me be clear: we are not without our challenges. But we are
already working to move beyond them and achieve the kind of
market leadership that we are fully capable of achieving.
2011 fi nancial results
Although our fundamental strategies are sound, we are not
satisfi ed with our 2011 fi nancial performance relative to the
market opportunities, and we intend to make considerable
progress in the short- and long-term by making signifi cant
improvements in the way we conduct our business. Net sales
totaled $513 million compared to net sales of $519 million the
previous year, a decrease of 1.2 percent. Net loss in 2011 totaled
$5.1 million compared to net income of $17.8 million in 2010.
Adjusted net income for the year totaled $32.8 million or $0.84
per diluted share.
We have been and continue to be committed to operating
our business in a manner consistent with the highest ethical
standards. Our board and management team took a number of
steps in 2011 to enhance our compliance environment. We will
continue to execute an effective and effi cient compliance system,
which is critical to success in our industry. We will build on the
progress we made throughout last year and are very optimistic
that we will successfully conclude the Deferred Prosecution
Agreement at the end of September of this year.
Well positioned in two large markets
We are very well positioned with two product platforms that
address the signifi cant orthopaedic markets of Extremities,
Biologics and Ortho-Recon.
Extremities and Biologics. The total global extremities and
biologics market is approximately $3.7 billion, about $1.4 billion of
which comprises foot and ankle. We believe we have the most
comprehensive product portfolio in the foot and ankle area, and
are the recognized leader in this market. The foot and ankle
market is expected to grow approximately 8 to 10 percent per
year and offers higher margins than the Ortho-Recon business. In
our portfolio today, Extremities and Biologics represent about 40
percent of our total revenues.
Ortho-Recon. The other part of our business, accounting for
approximately 60 percent of our total revenues, is Ortho-Recon,
our portfolio of innovative hip and knee products. With a global
size of about $12 billion, this is a much larger market than the
extremities market. However, we expect it to experience either fl at
or very low growth. Our current business is fairly well balanced
between the U.S. and international markets. Our strong global
coverage includes direct sales in major markets, distributors in
more than 60 countries, 80 international stocking distributors, and
more than 1,100 sales representatives. Because of this market’s
projected slow growth, we expect to emphasize driving signifi cant
improvements in customer satisfaction along with a focused R&D
product pipeline. This approach should enable us to generate
signifi cantly more cash both from inventory reduction and our
ability to spend more effectively.
Strategic priorities
I took on this opportunity with Wright Medical because I have great
respect for the company’s history of technology development and
innovation and the potential that we have to build a great and
sustainable company that serves our customers, employees,
and partners while creating value for stockholders. While we
have many strengths, we have much work to do to realize the
full potential that I believe this company is capable of reaching.
Since I arrived, I have spent a great deal of time collecting
information from employees and customers and working with our
management team to develop effective strategies to implement
going forward.
Based on this disciplined, data-driven process, we have
determined the vital few projects that have the most leverage
and how to best win in our key product categories of Extremities
and Biologics and Ortho-Recon. I am confi dent that we are in
large and attractive markets with a broad and technologically
advanced portfolio of products to serve our customers. We have
already taken many positive steps to better position the company
for success, including strengthening our compliance program
and implementing a plan to reduce operational costs. And we
will be implementing a number of important changes over the
next several months to transform our business and maximize the
opportunities we have.
2 2011 Annual Report Wright Medical Group, Inc.
Our top priorities are growing our Foot and Ankle business
above market rates, running a much more focused and effi cient
recon business, and increasing cash generation. I believe these
initiatives will in turn drive shareholder value.
Extremities and Biologics. We are taking proactive steps to
maximize the opportunity we see in our Extremities and Biologics
business, particularly in the Foot and Ankle market. We plan to
make the necessary investments to aggressively convert a major
portion of our U.S. independent distributor foot and ankle territories
to direct sales representation in order to increase sales productivity
and maximize the opportunity that we see in this business. We
would like to increase productivity over time from an average of
about $600,000 per rep per year to approximately $1 million.
At the same time, we are substantially increasing our investment
in Foot and Ankle medical education to drive market adoption of
new products and technologies. To this end, we intend to train
approximately 1,200 surgeons in 2012, twice as many as in 2011.
We further plan to roll out a new local training program to provide
increased access to surgeon training as well as conduct ongoing
regional labs and national events throughout 2012.
We intend to increase our allocation of our R&D spending to add
to our already robust product portfolio. By this time next year,
we expect to have more than 80 products in our Foot and Ankle
portfolio—products that meet of the majority of the needs of
physicians in this area, increase ease-of-use, and can be trained
effectively through our medical education efforts.
We believe that our increase in U.S. direct Foot and Ankle sales
representation, coupled with our increased investment in medical
education and large and growing product portfolio, will enable
us to improve our growth rates in Foot and Ankle throughout 2012
and exit the year at well above market growth rates.
Ortho-Recon. We will focus on driving signifi cant improvements
in customer satisfaction, cash generation, and operational
effi ciency in our Ortho-Recon business. This does not mean that
we are de-emphasizing this portion of our business in any way.
What it does mean is that we will implement programs to improve
customer communications and deliver consistently high levels
of service. It is also our plan to tenaciously defend our current
position. We will also seek to improve effi ciencies through product
line optimization supported with targeted sales and marketing
efforts and very focused R&D projects to improve our fl agship hip
and knee product lines. With this focus, I am confi dent that we will
be able to work toward building a stable Ortho-Recon business
that delivers exceptional levels of customer satisfaction and
generates cash.
Cash fl ow. We intend to signifi cantly reduce inventories to
improve overall cash fl ow. We have a plan that reduces inventory
by approximately $100 million over the next four years. We
already have multiple examples of areas within our company that
are performing dramatically better in inventory and instrument
utilization. We have developed a very focused plan, which gives
us a high level of confi dence that we will signifi cantly improve in
this area over time while moving our operating margins to the
mid-double digits. At the same time, we are placing a strong
focus on customer satisfaction. Quite frankly, we have some
work to do in this department and are taking steps to improve
the way we communicate with our customers. We currently have
unsatisfactory rates of customer willingness to recommend and
we intend to turn that around.
Development opportunities. We plan to use our strong
balance sheet and increased cash fl ow to actively pursue internal
and external development opportunities to further accelerate
growth in our Extremities and Biologics business.
A positive outlook
The transformational changes I have outlined will require
signifi cant investment in 2012, which will negatively impact our
full-year 2012 results. However, we believe these investments
will generate signifi cant future returns, including accelerating
Foot and Ankle sales growth rates and improving inventory
management and cash generation. We are enthusiastic about
our plan and look forward to executing our current strategies and
improving our performance.
If we are successful in pursuing these strategies, I further
believe that within three to fi ve years, Wright Medical will be
acknowledged as the global market leader in Foot and Ankle and
rated at the top in customer satisfaction. As we move forward,
I also expect the company to have a strong free cash fl ow,
improved operating margins, and a more balanced geographic
revenue mix.
I believe the future for Wright Medical is very bright, and I’m
confi dent we will be able to capitalize on the market opportunities
in front of us and build a leading global orthopaedic business.
Thank you for your trust and support of our efforts so far. We
look forward to working hard and producing great results for our
customers, employees, and stockholders in 2012 and beyond.
Sincerely yours,
Robert J. Palmisano
President and Chief Executive Offi cer
“ ... the future for Wright Medical is very bright ...”
2011 Annual Report Wright Medical Group, Inc. 3
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Table of Contents
Management's Discussion and Analysis of Financial
Condition and Results of Operations
This annual report contains “forward-looking statements” as defined
under United States federal securities laws. These statements reflect
management’s current knowledge, assumptions, beliefs, estimates, and
expectations and express management’s current views of future
performance, results, and trends and may be identified by their use of
terms such as “anticipate,” “believe,” “could,” “estimate,” “expect,”
“intend,” “may,” “plan,” “predict,” “project,” “will,” and other similar
terms. Forward-looking statements are subject to a number of risks and
uncertainties that could cause our actual results to materially differ
from those described in the forward-looking statements. Readers
should not place undue reliance on forward-looking statements. Such
statements are made as of the date of this Annual Report on Form 10-K,
and we undertake no obligation to update such statements after this
date. Risks and uncertainties that could cause our actual results to
materially differ from those described in forward-looking statements
include those discussed in our filings with the Securities and Exchange
Commission (including those described in Item 1A of this Annual
Report on Form 10-K for the year ended December 31, 2011, under the
heading, “Risk Factors” and elsewhere in this report), and the following:
•
•
result
future actions of the FDA or any other regulatory body or
government authority that could delay, limit or suspend product
development, manufacturing or sale or
in seizures,
injunctions, monetary sanctions or criminal or civil liabilities;
the impact of any such future actions of the FDA or any other
regulatory body or government authority on our settlement of the
into our consulting arrangements with
federal
orthopaedic surgeons relating to our hip and knee products in the
United States, and the impact of such settlement of the federal
investigation into our consulting arrangements with orthopaedic
surgeons relating to our hip and knee products in the United States,
including our compliance with the Deferred Prosecution Agreement
(DPA) through September 2012 and the Corporate
Integrity
Agreement (CIA) through September 2015;
investigation
• compliance reviews, the results of which may be required to be
disclosed to the Monitor, the United States Department of Justice,
and the Office of the Inspector General of the United States
Department of Health and Human Services under the under the
terms of the DPA and CIA, may uncover violations of law, including
strict liability provisions of the federal Food, Drug and Cosmetic Act
that could lead to adverse action by the FDA or others;
the possibility of litigation brought by stockholders, including
private securities litigation and stockholder derivative suits, which, if
initiated, could divert management's attention, harm our business
and/or reputation and result in significant liabilities;
•
• demand for and market acceptance of our new and existing
•
•
legislation and
products;
its future
recently enacted healthcare reform
implementation, possible additional legislation, regulation and
other governmental pressures in the United States or globally,
which may affect pricing, reimbursement, taxation and rebate
policies of government agencies and private payors or other
elements of our business;
tax reform measures, tax authority examinations and associated tax
risks and potential obligations;
to
identify business development and growth
• our ability
opportunities for existing or future products;
•
launch delays, sanctions, seizures,
• product quality or patient safety issues, leading to product recalls,
litigation or
withdrawals,
declining sales;
individual, group or class action alleging products liability claims,
including an increase in the number of claims during any period;
• our ability to enforce our patent rights or patents of third parties
preventing or restricting the manufacture, sale or use of affected
products or technology;
the impact of geographic and product mix on our sales;
retention of our sales representatives and independent distributors;
in buying patterns by
fluctuations
inventory reductions or
wholesalers or distributors;
•
•
•
The following management’s discussion and analysis of
financial condition and results of operations (MD&A) describes
the principal factors affecting the results of our operations,
financial condition, and changes in financial condition, as well
as our critical accounting estimates. MD&A is organized as
follows:
Executive Overview. This section provides a general
description of our business, a brief discussion of our principal
product lines, significant developments in our business, and
the opportunities, challenges and risks we focus on in the
operation of our business.
Results of Operations. This section provides our analysis of
and outlook for the significant line items on our consolidated
statement of operations.
Seasonal Nature of Business. This section describes the
effects of seasonal fluctuations in our business.
Liquidity and Capital Resources. This section provides an
analysis of our liquidity and cash flow and a discussion of our
outstanding debt and commitments.
Critical Accounting Estimates. This section discusses the
accounting estimates that are considered important to our
financial condition and results of operations and require us to
exercise subjective or complex judgments in their
application. All of our significant accounting policies,
including our critical accounting estimates, are summarized
in Note 2 to our consolidated financial statements.
Quantitative & Qualitative Disclosures About Market Risk
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Cash Flows
Consolidated Statements of Changes in Stockholders’
Equity and Comprehensive Income
Notes to Consolidated Financial Statements
Management’s Annual Report on Internal Control Over
Financial Reporting
Corporate Information
6
9
13
13
16
19
20
22
23
24
25
27
49
50
• our ability to realize the anticipated benefits of restructuring
initiatives;
• any impact of the commercial and credit environment on us and
•
our customers and suppliers; and
the
implementation of our new compliance enhancements,
including the duration and severity of delays related to medical
education, research and development and clinical studies, and the
impact of any such delays on our relationships with customers.
5
Executive Overview
Company Description. We are a global orthopaedic medical device company specializing in the design, manufacture and marketing of devices
and biologic products for extremity, hip, and knee repair and reconstruction. Extremity hardware includes implants and other devices to replace
or reconstruct injured or diseased joints and bones of the foot, ankle, hand, wrist, elbow and shoulder, which we generally refer to as either foot
and ankle or upper extremity products. We are a leading provider of surgical solutions for the foot and ankle market. Reconstructive devices are
used to replace or repair knee, hip and other joints and bones that have deteriorated or been damaged through disease or injury. Biologics are
used to repair or replace damaged or diseased bone, to stimulate bone growth and to provide other biological solutions for surgeons and their
patients. Within these markets, we focus on the higher-growth sectors of the orthopaedic industry, such as the foot and ankle market, as well as
on the integration of our biologic products into reconstructive procedures and other orthopaedic applications. Our extensive foot and ankle
product portfolio, our over 200 specialized foot and ankle sales representatives, and our increasing level of training of foot and ankle surgeons
has resulted in our being a recognized leader in the foot and ankle market. We have been in business for over 60 years and have built a well-
known and respected brand name.
Our corporate headquarters and U.S. operations are located in Arlington, Tennessee, where we conduct research and development, sales and
marketing administration, manufacturing, warehousing and administrative activities. Our U.S. sales accounted for 58% of total revenue in 2011.
Outside the U.S., we have distribution and administrative facilities in Amsterdam, the Netherlands, and sales and distribution offices in Canada,
Japan and throughout Europe. We market our products in approximately 60 countries through a global distribution system that consists of a
sales force of approximately 1,150 individuals who promote our products to orthopaedic surgeons and hospitals and other healthcare facilities.
At the end of 2011, we had approximately 400 sales associates and independent sales distributors in the U.S., and approximately 750 sales
representatives internationally, who were employed through a combination of our stocking distribution partners and direct sales offices.
Principal Products. We primarily sell devices and biologic products for extremity, hip, and knee repair and reconstruction. We specialize in
extremity and biologic products used by extremity focused surgeon specialists for the reconstruction, trauma and arthroscopy markets. Our
biologics sales encompass a broad portfolio of products designed to stimulate and augment the natural regenerative capabilities of the human
body. We also sell orthopaedic products not considered to be part of our knee, hip, extremity or biologic product lines.
Our extremities product line includes products for both the foot and ankle and the upper extremity markets. Our principal foot and ankle
portfolio includes the PRO-TOE® VO Hammertoe System, the CHARLOTTE™ foot and ankle system, the DARCO® family of locked plating systems,
the INBONE™ total ankle system, the VALOR™ ankle fusion nail system, and the Swanson line of toe joint replacement products. Our upper
extremity portfolio includes the MICRONAIL® intramedullary wrist fracture repair system, the EVOLVE® radial head prosthesis for elbow fractures,
the RAYHACK® osteotomy system, and the EVOLVE® Elbow Plating System.
Our biologic products focus on biological musculoskeletal repair and include synthetic and human tissue-based materials. Our principal biologic
products include the GRAFTJACKET® line of soft tissue repair and containment membranes, the ALLOMATRIX® line of injectable tissue-based bone
graft substitutes, the PRO-DENSE® injectable regenerative graft, the OSTEOSET® synthetic bone graft substitute, and the PRO-STIM™ injectable
inductive graft.
Our knee reconstruction products position us well in the areas of total knee reconstruction, revision replacement implants and limb preservation
products. Our principal knee products are the ADVANCE® knee system, the EVOLUTION™ Medial-Pivot Knee System, and the PROPHECY™ pre-
operative navigation guides for knee replacement, and our REPIPHYSIS® implant.
Our hip joint reconstruction product portfolio provides offerings in the areas of bone-conserving implants, total hip reconstruction, revision
replacement implants and limb preservation. Our hip reconstruction products include CONSERVE® family of products, the PROFEMUR® family of
hip stems and the DYNASTY™ acetabular cup system.
Significant Business Developments. Net sales declined 1% in 2011, totaling $512.9 million, compared to $519.0 million in 2010, as growth in our
extremity product line was offset by declines in our other product lines.
Our 2011 domestic sales were down 5%, as a 7% increase in extremities sales was offset by a 15% decline in biologics sales, a 14% decline in hip
sales, and a 4% decline in knee sales. Our U.S. sales were negatively affected by distributor transitions and challenges associated with
implementing enhancements to our compliance processes. As anticipated, these challenges have resulted in a slowdown in medical education
and research and development projects. Additionally, our U.S. hip and knee sales in particular, continue to be affected by the overall market
conditions experienced throughout the industry, including declining procedure volumes and pricing.
Our international sales increased by 4% during 2011 as compared to 2010 driven by favorable foreign currency exchange rates.
In 2011, we had a net loss of $5.1 million, compared to $17.8 million of net income in 2010. This decrease is primarily driven by $16.9 million
($10.7 million net of taxes) of charges related to restructuring and $13.2 million ($8.5 million net of taxes) related to management's estimate of
our liability for previous and estimated future fractures of our PROFEMUR® titanium long modular necks in North America, as well as higher levels
of costs associated with our Deferred Prosecution Agreement and the impact of our year-over-year sales decline.
In January 2011, we announced the extension of our supply agreement with LifeCell Corporation, a business unit of Kinetic Concepts, Inc.
(KCI) for the supply of GRAFTJACKET® Regenerative Tissue Matrix through December 2018 for orthopaedic markets. In addition, we entered into
an agreement with KCI to license our GRAFTJACKET® brand to KCI for exclusive use in wound markets for $8.5 million plus payments based on
future sales of the licensed products.
In February 2011, we announced that we had commenced a tender offer for any and all of our outstanding Convertible Senior Notes. Upon
expiration of the tender offer, we used the proceeds from a $150 million borrowing under a Term Loan facility available under our Senior Credit
Facility and cash on hand to fund the purchase of all $170.9 million of the Notes validly tendered in the tender offer and not withdrawn prior to
the expiration date. Following the closing of the tender offer, $29.1 million aggregate principal amount of the Notes remain outstanding.
6
During 2011, we made the following executive management changes:
•
•
•
•
Chief Executive Officer: On April 5, 2011, we announced that our Board of Directors elected David D. Stevens, the Chairman of our Board
of Directors, as interim President and Chief Executive Officer, replacing Gary D. Henley, who resigned as President and Chief Executive
Officer, and as a director. On September 19, 2011, we announced that our Board of Directors appointed Robert J. Palmisano as
President and Chief Executive Officer, effective September 17, 2011. Mr. Stevens remains the Chairman of our Board of Directors.
General Counsel: On May 4, 2011, Raymond C. Kolls, Senior Vice President, General Counsel and Secretary resigned. On December 29,
2011, we announced that James A. Lightman was named General Counsel and Secretary effective immediately.
Chief Compliance Officer: On August 16, 2011, Lisa L. Michels, Vice President and Chief Compliance Officer resigned from the
Company effective immediately. On January 30, 2012, we announced that Daniel Garen was named Senior Vice President and Chief
Compliance Officer effective immediately.
Other changes: On April 5, 2011, we announced that Frank S. Bono, Senior Vice President and Chief Technology Officer, was terminated
for inappropriate regard for our compliance program. Effective May 3 and 4, 2011, Alicia M. Napoli, Vice President, Clinical &
Regulatory Affairs, and Cary P. Hagan, Sr. Vice President, Commercial Operations - Europe, Middle East and Africa, respectively,
resigned from the Company.
In September 2011, we announced plans to implement a cost restructuring plan to foster growth, enhance profitability and cash flow, and build
stockholder value. We currently estimate the total cost associated with this plan to range from approximately $18 million to $25 million. During
2011, we recognized $16.9 million of restructuring charges in total, primarily for severance obligations, contract termination costs, and non-cash
asset impairment charges, as well as excess and obsolete inventory provisions. See Note 17 to our consolidated financial statements for further
discussion of our restructuring charges.
In September 2011, we announced that we reached an agreement with the United States Attorney’s Office for the District of New Jersey (USAO)
under which we voluntarily agreed to extend the term of the DPA for 12 months. We also agreed with the OIG-HHS to an amendment to the CIA
under which certain of WMT's substantive obligations under the CIA will now begin on September 29, 2012, when the amended DPA monitoring
period expires. See Note 18 to our condensed consolidated financial statements for further discussion of our DPA and CIA amendments.
In October 2011, we acquired the patented CCI® Evolution Mobile Bearing Total Ankle Replacement system of Van Straten Medical B.V. for
approximately $7.0 million. See Note 3 to our condensed consolidated financial statements for further discussion of this acquisition.
Opportunities and Challenges. We believe that we have an opportunity to transform our business to increase our foot and ankle revenue
growth rates and increase our cash generation through significant reduction of our inventories. In order to increase our foot and ankle growth
rates, we plan to make changes in 2012 to attempt to realize these opportunities, including aggressively converting a portion of our U.S.
independent distributor foot and ankle territories to direct sales representation, substantially increasing our investment in foot and ankle
medical education to drive market adoption of new products and technologies, and implementing steps to significantly reduce inventories over
the next several years.
These transformational changes for our business will require significant investment in 2012, which will negatively impact our sales results of
operations in 2012. However, we believe these investments will improve the performance of our business in the longer term.
We believe that our U.S. businesses will continue to be unfavorably affected by distributor transitions and challenges associated with
implementing enhancements to our compliance processes. Further, we expect that our U.S. and international businesses will continue to be
unfavorably affected by the market conditions being experienced throughout the hip and knee industry, including procedural growth rates
below historical levels and pricing declines.
Beginning in 2013, we will be subject to a 2.3% excise tax on U.S. sales of medical devices, as prescribed in the Patient Protection and Affordable
Care Act and the Health Care and Education Reconciliation Act (collectively known as the “Affordable Care Act”). The specific regulations on this
tax are still in draft form. We believe that the impact of this tax may have a negative impact on our profitability.
Significant Industry Factors. Our industry is affected by numerous competitive, regulatory, and other significant factors. The growth of our
business relies on our ability to continue to develop new products and innovative technologies, obtain regulatory clearance and compliance for
our products, protect the proprietary technology of our products and our manufacturing processes, manufacture our products cost-effectively,
respond to competitive pressures specific to each of our geographic markets, including our ability to enforce non-compete agreements, and
successfully market and distribute our products in a profitable manner. We, and the entire industry, are subject to extensive governmental
regulation, primarily by the United States Food and Drug Administration (FDA). Failure to comply with regulatory requirements could have a
material adverse effect on our business. Additionally, our industry is highly competitive and continues to experience pricing pressures,
specifically in the areas of reconstructive joint devices.
In December 2007, we received a subpoena from the United States Department of Justice (DOJ) through the United States Attorney’s Office for
the District of New Jersey (USAO) requesting documents for the period January 1998 through the present related to any consulting and
professional service agreements with orthopaedic surgeons in connection with hip or knee joint replacement procedures or products. This
subpoena was served shortly after several of our knee and hip competitors agreed with the DOJ to resolutions of similar investigations.
On September 29, 2010, our wholly-owned subsidiary, Wright Medical Technology, Inc. (WMT), entered into a 12-month Deferred Prosecution
Agreement (DPA) with the USAO and a Civil Settlement Agreement (CSA) with the United States. Under the DPA, the USAO filed a criminal
complaint in the United States District Court for the District of New Jersey charging WMT with conspiracy to commit violations of the Anti-
Kickback Statute (42 U.S.C. § 1320a-7b) during the years 2002 through 2007. The court deferred prosecution of the criminal complaint during the
term of the DPA and the USAO agreed that if WMT complied with the DPA's provisions, the USAO would seek dismissal of the criminal complaint.
7
Pursuant to the CSA, WMT settled civil and administrative claims relating to the matter for a payment of $7.9 million without any admission by
WMT. In conjunction with the CSA, WMT also entered into a five year Corporate Integrity Agreement (CIA) with the Office of the Inspector General
of the United States Department of Health and Human Services (OIG-HHS). Pursuant to the DPA, an independent monitor is reviewing and
evaluating WMT’s compliance with its obligations under the DPA. The DPA and the CIA were filed as Exhibits 10.3 and 10.2, respectively, to our
current report on Form 8-K filed on September 30, 2010. The DPA has also been posted to our website. Each of the DPA and the CIA could be
modified by mutual consent of the parties thereto.
As a result of the work of the independent monitor and WMT’s compliance program, the Board of Directors became aware of facts indicative of
possible compliance issues. At the direction of the Nominating, Compliance and Governance Committee of the Board of Directors of WMT’s
parent, Wright Medical Group, Inc. (WMGI), WMGI and WMT conducted an internal investigation with the assistance of outside counsel. The
Board of Directors of WMGI received a report from outside counsel.
On May 4, 2011, our wholly-owned subsidiary Wright Medical Technology, Inc. (WMT) provided written notice to the independent monitor and to
the United States Attorney's Office for the District of New Jersey (USAO) of credible evidence of serious wrongdoing, pursuant to a notification
requirement in paragraph 20 of the Deferred Prosecution Agreement (DPA). On May 5, 2011, WMT received a letter from the USAO pursuant to
paragraph 50 of the DPA stating that the USAO believed that WMT had knowingly and willfully breached material provisions of the DPA. The
issues WMT is addressing relate to: (i) 42 U.S.C. § 1320a-7b(b) (also known as the “Anti-Kickback Statute”), specifically regarding certain
employees' communications with a health care professional for consulting opportunities in a manner not consistent with WMT's compliance
policy; (ii) the violation of Paragraph 25 of the DPA due to the communications with a healthcare professional noted above; and (iii) alleged
violations of Paragraph 17 of the DPA due to failure to provide information to the Monitor in a timely manner.
In order to resolve these issues, WMT has implemented a number of remedial measures, including: (i) taking appropriate personnel actions; (ii)
enhancing its policies and employee training with respect to compliance with the requirements of paragraph 8 of the DPA, which requires all
Company employees and agents to report suspected legal and policy violations, and paragraph 25 of the DPA, which governs interactions with
consultants on the terms of consulting agreements and payment issues; (iii) reviewing its existing relationships with certain customers and taking
appropriate further action where necessary with respect to these relationships; and (iv) clarifying lines of responsibility for making payments to
consultants. WMT continues to provide ongoing employee training and to review its relationships with customers, and is developing a protocol
for internal reporting and investigation of allegations of misconduct relating to senior management.
On September 15, 2011, WMT reached an agreement with the USAO and the OIG-HHS under which WMT voluntarily agreed to extend the term
of its DPA for 12 months. As amended, the DPA will now expire on September 29, 2012. The USAO has agreed not to take any additional action
regarding any breach of the DPA referenced in the aforementioned May 5, 2011 letter from the USAO unless it finds, prior to September 29, 2012,
that WMT has committed a knowing, willful and uncured breach of a material provision of the DPA by its conduct after September 15, 2011 or by
conduct before September 15, 2011 of which the independent monitor was not aware on that date. If WMT complies with all of the requirements
of the amended DPA, the USAO will seek dismissal of the pending criminal complaint. WMT also agreed with the OIG-HHS to an amendment to
the Corporate Integrity Agreement (CIA) under which certain of WMT's substantive obligations under the CIA will now begin on September 29,
2012, when the amended DPA monitoring period expires. The term of the CIA has not changed, and will expire as previously provided on
September 29, 2015. In connection with such amendment, the OIG-HHS informed WMT that it had no present intention, based on the
information then known to it, to exercise its authority under Paragraph 51 of the DPA to exclude Wright from participation in federal healthcare
programs based on any breach referenced in the May 5 letter unless the USAO were to take further action related to an alleged breach of the DPA
by WMT.
As previously disclosed, at the direction of the Company's Board of Directors, WMT has continued to implement compliance measures and to
take steps to enhance WMT's compliance environment. From time to time, WMT has provided, and may in the future provide, pursuant to
Paragraph 20 of the DPA, written notices to the independent monitor and the USAO of “credible evidence of violations of 21 U.S.C. § 331,” a strict
liability provision of the federal Food, Drug and Cosmetic Act (and any such notices have been and will be provided to the OIG-HHS). Paragraph
20 of the DPA requires WMT to provide written notice to the independent monitor and the USAO of credible evidence of violations of any
criminal statute, regardless of whether any such violations are material. WMT has conducted a review of its clinical and regulatory affairs
operations, and may conduct further reviews on an ongoing periodic basis. Although circumstances may change, the Company intends to
disclose in its future filings with the Securities and Exchange Commission any additional occasions when WMT provides written notice under
Paragraph 20 of the DPA or under the CIA only if such potential violation or violations, or any consequences therefrom, are required to be
reported under U.S. federal securities laws.
Under the DPA, the Company and the independent monitor perform their investigative activities, and communications amongst WMT and the
independent monitor, and other governmental agencies are ongoing. We are unable to predict the ultimate outcome of these activities.
The DPA and CIA impose certain obligations on WMT to maintain compliance with U.S. healthcare laws, regulations and other requirements. Our
failure to do so could expose us to significant liability including, but not limited to, exclusion from federal healthcare program participation,
including Medicaid and Medicare, which would have a material adverse effect on our financial condition, results of operations and cash flows,
potential prosecution, including under the previously-filed criminal complaint, civil and criminal fines or penalties, and additional litigation cost
and expense. A breach of the DPA or the CIA could result in an event of default under the Senior Credit Facility, which in turn could result in an
event of default under the Indenture.
In addition to the USAO and OIG-HHS, other governmental agencies, including state authorities, could conduct investigations or institute
proceedings that are not precluded by the terms of the settlements reflected in the DPA and the CIA. In addition, the settlement with the USAO
and OIG-HHS could increase our exposure to lawsuits by potential whistleblowers, including under the federal false claims acts, based on new
theories or allegations arising from the allegations made by the USAO. The costs of defending or resolving any such investigations or
proceedings could have a material adverse effect on our financial condition, results of operations and cash flows.
8
The successful implementation of our enhanced compliance program requires the full and sustained cooperation of our employees, distributors,
and sales agents as well as the healthcare professionals with whom they interact. These efforts may require increased expenses and additional
investments. We may also encounter inefficiencies in the implementation of our new compliance enhancements, including delays in medical
education, research and development projects, and clinical studies, which may unfavorably impact our business and our relationships with
customers. In addition, the 12 month extension of the DPA and the associated monitorship will result in continued expenses associated with the
monitor and may result in a further diversion of management time and attention from business issues which could have a negative impact on
our financial performance.
A detailed discussion of these and other factors is provided in “Risk Factors.”
Results of Operations
Comparison of the year ended December 31, 2011 to the year ended December 31, 2010
The following table sets forth, for the periods indicated, our results of operations expressed as dollar amounts (in thousands) and as percentages
of net sales:
Net sales
Cost of sales
Cost of sales - restructuring
Gross profit
Operating expenses:
Selling, general and administrative
Research and development
Amortization of intangible assets
Restructuring charges
Total operating expenses
Operating income
Interest expense, net
Other expense, net
Year Ended December 31,
2011
2010
Amount
% of Sales
Amount
% of Sales
$
512,947
100.0 % $
518,973
100.0 %
156,906
2,471
353,570
30.6 %
0.5 %
68.9 %
301,588
58.8 %
30,114
2,870
14,405
5.9 %
0.6 %
2.8 %
348,977
68.0 %
4,593
6,529
4,719
(6,655 )
(1,512 )
(5,143 )
0.9 %
1.3 %
0.9 %
(1.3 )%
(0.3 )%
(1.0 )% $
158,456
—
360,517
282,413
37,300
2,711
919
323,343
37,174
6,123
130
30,921
13,080
17,841
30.5 %
— %
69.5 %
54.4 %
7.2 %
0.5 %
0.2 %
62.3 %
7.2 %
1.2 %
0.0 %
6.0 %
2.5 %
3.4 %
(Loss) income before income taxes
(Benefit) Provision for income taxes
Net (loss) income
$
The following table sets forth our net sales by product line for the periods indicated (in thousands) and the percentage of year-over-year change:
Hip products
Knee products
Extremity products
Biologics products
Other
Total net sales
Year Ended December 31,
2011
2010
% Change
$
173,201 $
176,687
123,988
135,476
69,409
10,873
128,854
124,490
79,231
9,711
$
512,947 $
518,973
(2.0 )%
(3.8 )%
8.8 %
(12.4 )%
12.0 %
(1.2 )%
9
The following graphs illustrate our product line sales as a percentage of total net sales for the years ended December 31, 2011 and 2010:
Product Line Sales as a Percentage of Total Net Sales
2011
2010
Net sales. Our U.S. net sales totaled $295.9 million in 2011 and $310.0 million in 2010, representing approximately 58% of total net sales in 2011,
60% of total net sales in 2010 and a 5% decrease in 2011 compared to 2010. Our international net sales totaled $217.0 million in 2011, a 4%
increase as compared to net sales of $209.0 million in 2010. Our 2011 international net sales included a favorable foreign currency impact of
approximately $10.6 million when compared to 2010 net sales. The favorable currency impact and a 7% increase in sales in Japan were partially
offset by a 5% decrease in sales in Europe.
Our hip product net sales totaled $173.2 million in 2011, representing a 2% decrease over 2010. This decrease is attributable to a 14% decline in
U.S. hip sales, driven by an 11% decline in unit sales. The remaining decrease was driven by a decline in average selling prices. International hip
sales increased by 6%, attributable to a $6.4 million favorable currency impact compared to 2010.
Net sales of our knee products totaled $124.0 million in 2011, representing a decrease of 4% over 2010. In the U.S., knee sales decreased 4% over
2010 due primarily to decreased average selling prices. Internationally, knee sales decreased 4% in 2011 over 2010, primarily due to lower unit
sales, which was partially offset by a favorable currency impact of $2.0 million.
Our extremity product net sales increased to $135.5 million in 2011, representing growth of 9% over 2010. This increase was primarily driven by
our U.S. extremity business, which increased 7%, due primarily to our PRO-TOE™ VO Hammertoe Fixation System, launched in the first quarter of
2011, as well as the continued success of our INBONE™ products and our VALOR™ ankle fusion nail system, launched in the 2nd quarter of 2010.
International extremity sales growth of 15% was primarily due to the continued success of our DARCO plating system as well as a favorable
currency impact of $1.4 million.
Net sales of our biologic products totaled $69.4 million in 2011, which declined by 12%, as compared to 2010. Our U.S. biologics sales decreased
15% compared to 2010, primarily due to the license agreement entered into with KCI during the first quarter of 2011.
Cost of sales. Our cost of sales as a percentage of net sales increased slightly in 2011 compared to 2010 from 30.5% to 30.6% as increased
provisions for excess and obsolete inventory were mostly offset by favorable manufacturing expenses and favorable currency exchange rates.
Our cost of sales and corresponding gross profit percentages can be expected to fluctuate in future periods depending upon changes in our
product sales mix and prices, distribution channels and geographies, manufacturing yields, period expenses, levels of production volume and
currency exchange rates. During 2012, cost of sales may increase due to expenses associated with lower levels of production volume and higher
levels of excess and obsolete inventory provisions as we implement our strategy for significantly reducing inventories.
Cost of sales - restructuring. In 2011, we recorded charges of $2.5 million (0.5% of net sales) for excess and obsolete inventory provisions
associated with product optimization as we reduce the size of our international product portfolio.
Selling, general and administrative. Our selling, general and administrative expenses as a percentage of net sales totaled 58.8% and 54.4% in
2011 and 2010, respectively. Selling, general and administrative expense for 2011 included $7.0 million of non-cash, stock-based compensation
expense (1.4% of net sales), $12.9 million of costs associated with our U.S. government inquiries and our DPA (2.5% of net sales), and a provision
of $13.2 million recognized during the quarter ended September 30, 2011, for management's estimate of our total liability for claims associated
with previous and estimated future fractures of our titanium PROFEMUR® long modular necks in North America (2.6% of net sales). During 2010,
selling, general and administrative expense included $9.9 million of non-cash, stock-based compensation expense (1.9% of net sales) and
$10.9 million of costs associated with our U.S. government inquiries and our DPA (2.1% of net sales). The increase in selling, general and
administrative expense as a percentage of sales is primarily attributable to the provision recorded for product liability discussed above, as well as
increased spending on our global compliance efforts and legal fees, which were partially offset by decreased spending on medical education.
10
The successful implementation of our enhanced compliance program requires the full and sustained cooperation of our employees, distributors,
and sales agents as well as the healthcare professionals with whom they interact. These efforts may require increased expenses. In addition, the
12 month extension of the DPA and the associated monitorship has resulted in continued expenses associated with the monitor. Further, as part
of our enhanced compliance program, we are in the process of evaluating our royalty agreements with our physician consultants. If we
determine that any of these royalty agreements require termination or amendment, the settlement of such termination or amendment may have
a significant impact on our results of operations.
Research and development. Our investment in research and development activities represented 5.9% and 7.2% of net sales in 2011 and 2010,
respectively. Our research and development expense included non-cash, stock-based compensation expense of $0.7 million (0.1% of net sales) in
2011, compared to $1.9 million (0.4% of net sales) in 2010. The remaining decrease in research and development expense as a percentage of
sales is primarily attributable to decreased spending on research and development activities and clinical studies as we encountered certain
inefficiencies associated with the implementation of our enhanced compliance program.
Amortization of intangible assets. Charges associated with amortization of intangible assets totaled $2.9 million in 2011, as compared to $2.7
million in 2010. Based on the intangible assets held at December 31, 2011, we expect to amortize $2.8 million in 2012, $2.4 million in 2013, $2.2
million in 2014, $2.2 million in 2015 and $2.0 million in 2016.
Restructuring Charges. During 2011, we recognized $14.4 million of restructuring charges within operating expenses, primarily for severance
obligations and the impairment of long-lived assets. We believe that the remaining restructuring charges of approximately $18 million to $25
million will likely be recorded in the first half of 2012.
Interest expense, net. Interest expense, net, consists of interest expense of $7.0 million and $6.6 million in 2011 and 2010, respectively, primarily
from borrowings under the Term Loan for 2011 under our Senior Credit Facility, and our Notes for 2010, offset by interest income of $0.4 million
and $0.5 million during 2011 and 2010, respectively, generated by our invested cash balances and investments in marketable securities. The
amounts of interest income we realize in 2012 and beyond are subject to variability, dependent upon both the rate of invested returns we realize
and the amount of excess cash balances on hand. Additionally, the amount of interest expense we incur is subject to variability dependent upon
the change in London Interbank Offered Rate (LIBOR) rates and our consolidated leverage ratio.
Other expense, net. Other expense, net includes approximately $4.1 million of expenses in 2011 for the write off of pro-rata unamortized
deferred financing fees and for bank and legal fees associated with the purchase of $170.9 million aggregate principal amount of the Notes
validly tendered in the tender offer.
(Benefit)/Provision for income taxes. We recorded tax benefit of $1.5 million in 2011 and tax provision of $13.1 million in 2010. Our effective tax
rate for 2011 and 2010 was 22.7% and 42.3% respectively. The unfavorable trend in the effective tax rate in 2011 was primarily due to a $1.0
million provision associated with the initial assessments from the examination of our 2008 income tax return by the Internal Revenue Service.
Effective January 1, 2012, the research and development credit expired. If this credit is not reinstated, our income tax provision could be
unfavorably impacted by less than $1.0 million.
Comparison of the year ended December 31, 2010 to the year ended December 31, 2009
The following table sets forth, for the periods indicated, our results of operations expressed as dollar amounts (in thousands) and as percentages
of net sales:
Year Ended December 31,
2010
2009
Amount
% of Sales
Amount
% of Sales
Net sales
Cost of sales
Gross profit
Operating expenses:
Selling, general and administrative
Research and development
Amortization of intangible assets
Restructuring charges
Total operating expenses
Operating income
Interest expense, net
Other expense, net
Income before income taxes
Provision for income taxes
Net income
518,973
158,456
360,517
282,413
37,300
2,711
919
323,343
37,174
6,123
130
30,921
13,080
17,841
$
$
11
100.0 % $
30.5 %
69.5 %
54.4 %
7.2 %
0.5 %
0.2 %
62.3 %
7.2 %
1.2 %
0.0 %
6.0 %
2.5 %
3.4 % $
487,508
148,715
338,793
270,456
35,691
5,151
3,544
314,842
23,951
5,466
2,873
15,612
3,481
12,131
100.0 %
30.5 %
69.5 %
55.5 %
7.3 %
1.1 %
0.7 %
64.6 %
4.9 %
1.1 %
0.6 %
3.2 %
0.7 %
2.5 %
The following table sets forth our net sales by product line for the periods indicated (in thousands) and the percentage of year-over-year change:
Hip products
Knee products
Extremity products
Biologics products
Other
Total net sales
Year Ended December 31,
2010
2009
% Change
$
176,687 $
167,869
128,854
124,490
79,231
9,711
122,178
107,375
79,120
10,966
$
518,973 $
487,508
5.3 %
5.5 %
15.9 %
0.1 %
(11.4 )%
6.5 %
The following graphs illustrate our product line sales as a percentage of total net sales for the years ended December 31, 2010 and 2009:
Product Line Sales as a Percentage of Total Net Sales
2010
2009
Net sales. Our U.S. net sales totaled $310.0 million in 2010 and $299.6 million in 2009, representing approximately 60% of total net sales in 2010,
61% of total net sales in 2009 and a 3% increase in 2010 over 2009. Our international net sales totaled $209.0 million in 2010, an 11% increase as
compared to net sales of $187.9 million in 2009. Our 2010 international net sales included a favorable foreign currency impact of approximately
$1.5 million when compared to 2009 net sales, due to the 2010 favorable performance of the Japanese yen and the Canadian dollar against the
U.S. dollar, which was partially offset by the unfavorable performance of the euro against the U.S. dollar.
From a product line perspective, our net sales growth for 2010 was attributable to increases in our extremity, hip and knee product lines of 16%,
5% and 5%, respectively, while our biologics product line remained flat. During 2010, our extremity sales growth was primarily driven by our U.S.
business, which increased 14%, primarily due to the continued success of our INBONE™ total ankle system, our increased sales of our ORTHOLOC™
polyaxial trauma plating system, and increased sales of VALOR ankle fusion nail system. The increase in our hip product sales was driven by
increased sales of our PROFEMUR® hip system. Sales of our knee products increased in 2010 compared to the prior year as a result of increased
unit sales, which were partially offset by declines in pricing.
Cost of sales. Our cost of sales as a percentage of net sales was 30.5% in both 2009 and 2010. Unfavorable geographic mix shifts, as our more
profitable U.S. sales decreased as a percentage of total sales, along with unfavorable pricing in our U.S. hip and knee business were offset by
lower levels of excess and obsolete inventory provisions and favorable manufacturing expenses.
Operating expenses. Our total operating expenses, as a percentage of net sales, decreased by 2.3 percentage points to 62.3% in 2010 from
64.6% in 2009, as lower levels of restructuring charges and amortization expenses were partially offset by increased expenses associated with our
U.S. government inquires and our DPA. Additionally our 2009 operating expenses included a $5.6 million (1.1% of net sales) provision for
potential losses associated with a trade receivable.
12
Interest expense, net. Interest expense, net, consists of interest expense of $6.6 million and $6.5 million in 2010 and 2009, respectively, primarily
from our $200 million of Convertible Senior Notes due 2014 issued in November 2007. This was partially offset by interest income of $0.5 million
and $1.0 million during 2010 and 2009, respectively, generated by our invested cash balances and investments in marketable securities. The
decline in interest income was due to the overall decline in interest rates on our invested cash balances and investments in marketable securities
during 2010.
Other expense, net. Other expense, net, totaled $0.1 million of expense during 2010 compared to $2.9 million of expense during 2009. During
2009, we recognized $2.6 million of expense related to the write-off of the CTA balances for certain subsidiaries that had been substantially
liquidated as part of our restructuring of operations in Toulon, France.
Provision for income taxes. Our effective tax rate for 2010 and 2009 was 42.3% and 22.3%, respectively. The increase in our effective tax rate was
primarily due to changes in our valuation allowance in both years, higher levels of non-deductible expenses in 2010, primarily due to a portion of
the civil settlement payment that is considered not deductible, and the greater impact of certain deductions on our lower income in 2009.
Seasonal Nature of Business
We traditionally experience lower sales volumes in the third quarter than throughout the rest of the year as many of our reconstructive products
are used in elective procedures, which generally decline during the summer months, typically resulting in selling, general and administrative
expenses and research and development expenses as a percentage of sales that are higher during this period than throughout the rest of the
year. In addition, our first quarter selling, general and administrative expenses include additional expenses that we incur in connection with the
annual meeting held by the American Academy of Orthopaedic Surgeons (AAOS) and the American College of Foot and Ankle Surgeons (ACFAS).
The AAOS meeting, which is the largest orthopaedic meeting in the world, features the presentation of scientific papers and instructional courses
for orthopaedic surgeons. During this three-day event, we display our most recent and innovative products for these surgeons. The ACFAS
meeting, similar to AAOS, is another three-day event to display our latest innovations in the foot and ankle market.
Restructuring
On September 15, 2011, we announced plans to implement a cost restructuring plan to foster growth, enhance profitability and cash flow, and
build stockholder value. We have implemented numerous initiatives to reduce spending, including streamlining select aspects of our
international selling and distribution operations, reducing the size of our product portfolio, adjusting plant operations to align with our volume
and mix expectations and rationalizing our research and development projects. In total, we reduced our workforce by approximately 80
employees, or 6%. We have estimated that total pre-tax restructuring charges will be approximately $18 million to $25 million, of which we
recognized $16.9 million in 2011. We expect the remaining charges to be recorded during the first half of 2012. We anticipate that recording the
remaining $1 million to $8 million of restructuring expenses could have a material impact on our results of operations in the period incurred;
however, we do not expect that the restructuring expenses will have an impact on our financial condition or liquidity. We have realized the
benefits from this restructuring within selling, general and administrative expenses and research and development expenses in the fourth
quarter of 2011 and expect to achieve additional savings beginning in 2012, partially offset by unfavorable income tax consequences, and
incremental expenses associated with senior management changes. In total, our net income will have an approximately $2 million favorable
impact beginning in 2012 on an annual basis. Additionally, beginning in 2013, we expect to realize additional benefits within cost of sales, the
net income impact of which is approximately $1 million annually. However, the favorable impact from our cost improvement restructuring plan
in 2012 will be more than offset by the additional investments we are making in 2012 for the transformational changes discussed above in
“Opportunities and Challenges.” See Note 17 to our condensed consolidated financial statements for further discussion of our restructuring
charges.
Liquidity and Capital Resources
The following table sets forth, for the periods indicated, certain liquidity measures (in thousands):
Cash and cash equivalents
Short-term marketable securities
Long-term marketable securities
Working capital
Line of credit availability
As of December 31,
2011
2010
$
153,642 $
153,261
13,597
4,502
424,543
42,000
19,152
17,193
426,286
100,000
In 2010, we began investing in long-term marketable securities with maturity dates ranging from 17 to 36 months, consisting of investments in
government, agency, and corporate bonds. As of December 31, 2011, the weighted average maturity for these investments was 13 months.
Operating Activities. Cash provided by operating activities totaled $61.4 million, $73.2 million, and $71.8 million in 2011, 2010 and 2009
respectively. The decrease in cash provided by operating activities in 2011 as compared to 2010 was due to decreased profitability, primarily
associated with cash paid for restructuring charges of approximately $9.9 million.
In 2010 compared to 2009, the increase in cash from operating activities was primarily due to a decrease in our provision for deferred taxes,
which was mostly offset by changes in working capital, primarily due to the decrease in our inventory balance in 2009.
13
Investing Activities. Our capital expenditures totaled $47.0 million in 2011, $49.0 million in 2010, and $37.2 million in 2009. The increase in 2010
compared to 2009 is attributable to increased spending on manufacturing equipment and surgical instrumentation primarily associated with our
recent launch of our EVOLUTION™ medial-pivot knee system, as well as increased spending related to the expansion of our facilities in Arlington,
Tennessee. Capital expenditures remained relatively flat in 2011 as decreases in spending on the previously discussed spending on
manufacturing equipment and facilities expansion was offset by capital expenditures associated with the upgrade of our enterprise resource
planning system. Historically, our capital expenditures have consisted principally of purchased manufacturing equipment, research and testing
equipment, computer systems, office furniture and equipment and surgical instruments. We expect to incur capital expenditures in 2012 of
approximately $30 million for routine capital expenditures.
Financing Activities. During 2011, cash used in financing activities totaled $30.1 million, compared to cash used in financing activities in 2010 of
$0.2 million and cash provided by financing of $0.5 million in 2009. The change is primarily attributable to the payments to fund the purchase of
$170.9 million of the Notes validly tendered in the tender offer, mostly offset by the cash proceeds from a $150 million borrowing under the Term
Loan.
In 2012, we will make continued payments under our long-term capital leases, including interest, of $1.1 million.
In November 2007, we issued $200 million of 2.625% Convertible Senior Notes due 2014 (Notes). The Notes will mature on December 1, 2014.
The Notes pay interest semiannually at an annual rate of 2.625% and are convertible into shares of our common stock at an initial conversion rate
of 30.6279 shares per $1,000 principal amount of the Notes subject to adjustment upon the occurrence of specified events, which represents an
initial conversion price of $32.65 per share. The holder of the Notes may convert at any time on or prior to the close of business on the business
day immediately preceding the maturity date of Notes. Beginning on December 6, 2011, we may redeem the notes, in whole or in part, at a
redemption price equal to 100% of the principal amount of the Notes, plus accrued and unpaid interest, if the closing price of our common stock
has exceeded 140% of the conversion price for at least 20 days during any consecutive 30-day trading period. Additionally, if we experience a
fundamental change event, as defined in the indenture governing the Notes (Indenture), the holders may require us to purchase for cash all or a
portion of the Notes, for 100% of the principal amount of the notes, plus accrued and unpaid interest. If upon a fundamental change event, a
holder elects to convert its Notes, we may, under certain circumstances, increase the conversion rate for the Notes surrendered. The Notes are
unsecured obligations and are effectively subordinated to (i) all of our existing and future secured debt, including our obligations under our
credit agreement, to the extent of the value of the assets securing such debt, and (ii) because the Notes are not guaranteed by any of our
subsidiaries, to all liabilities of our subsidiaries.
On February 10, 2011, we announced the commencement of a tender offer to purchase for cash any and all of our outstanding Notes. Upon
expiration on March 11, 2011, we purchased $170.9 million aggregate principal amount of the Notes. As a result of this transaction, we
recognized approximately $4.1 million for the write off of pro-rata unamortized deferred financing fees and for bank and legal fees associated
with the purchase. As of December 31, 2011, $29.1 million aggregate principal amount of the Notes remain outstanding.
On February 10, 2011, we entered into an amended and restated revolving credit agreement (Senior Credit Facility). The Senior Credit Facility has
revolver availability of $200 million and availability in a delayed draw term loan of up to $150 million. The total availability can be increased by up
to an additional $100 million at our request and subject to the agreement of the lenders. Borrowings under the Senior Credit Facility will bear
interest at the sum of a base rate or a Eurodollar rate plus an applicable margin that ranges from 0.0% to 2.75%, depending on the type of loan
and our consolidated leverage ratio. The term of the Senior Credit Facility extends through February 10, 2016. As a result of this transaction, we
incurred deferred financing charges of approximately $2.9 million, which will be amortized over the term of the Senior Credit Facility.
In March 2011, to fund the purchase of the Notes, we borrowed $150 million under the delayed draw term loan (Term Loan) facility available
under our Senior Credit Facility. The Term Loan bears interest at a one month London Interbank Offered Rate (LIBOR) rate, plus a margin based
on our consolidated leverage ratio as defined in the Senior Credit Facility. As of December 30, 2011, the one month LIBOR was 0.30% and the
applicable margin was 2.25%. Quarterly repayments of the original principal amount of the Term Loan are required under the Senior Credit
Facility, with the remaining principal amount due on February 10, 2016.
In March 2011, we entered into an interest rate swap agreement, which we designated as cash flow hedge of the underlying variable rate
obligation on our Term Loan. We did not have any interest rate swap agreements outstanding as of December 31, 2010. See Note 11 for
additional information regarding the interest rate swap agreement.
The payment of our indebtedness under the Senior Credit Facility is secured by pledges of 100% of the capital stock of our U.S. subsidiaries and
65% of the capital stock of our material foreign subsidiaries, and is guaranteed by our material domestic subsidiaries. The Senior Credit Facility
contains customary financial and non-financial covenants. Upon the occurrence of an event of default, the lenders may declare that all principal,
interest and other amounts owed are immediately due and payable and may exercise any other available right or remedy. The events of default
include, but are not limited to, non-payment of amounts owed, failure to perform covenants, breach of representations and warranties,
institution of insolvency proceedings, entry of certain judgments, and occurrence of a change in control.
Currently, the calculation of our leverage ratio in our Senior Credit facility agreement does not add back cash restructuring charges and expenses
associated with our DPA since its extension. In order to ensure compliance with our leverage ratio, it is possible that we may make an additional
cash payment of $30 million to $50 million to reduce our debt during 2012. Because the restructuring charges and DPA expenses will not have an
ongoing impact on our EBITDA calculation and debt covenant ratios, it is also possible that our Senior Credit facility will be amended to allow
these charges as addbacks and therefore, we would not need to make the additional principal payment described above. However, there can be
no assurance the lender will grant these additional modifications to the current debt agreement.
As of December 31, 2011, we had an immaterial amount of cash and cash equivalents held in jurisdictions outside of the U.S., which are expected
to be indefinitely reinvested for continued use in foreign operations. Repatriation of these assets to the U.S. would have negative tax
consequences. The Company does not intent to repatriate funds.
14
—
—
—
398
—
Contractual Cash Obligations. At December 31, 2011, we had contractual cash obligations and commercial commitments as follows (in
thousands):
Payments Due by Periods
Total
2012
2013-2014
2015-2016
After 2016
Amounts reflected in consolidated balance sheet:
Lease obligations(1)
Convertible Senior Notes(2)
Term Loan(3)
$
1,950 $
1,080 $
867 $
29,111
—
29,111
3 $
—
144,375
7,500
28,125
108,750
Amounts not reflected in consolidated balance sheet:
Operating leases
Interest on Convertible Senior Notes(4)
Interest on Term Loan(5)
Royalty and consulting agreements
Total contractual cash obligations
_______________________________
17,928
2,231
12,493
715
8,754
765
3,562
147
8,002
1,466
6,216
284
774
—
2,715
—
284
—
$
208,803 $
21,808 $
74,071 $
112,526 $
398
(1) Payments include amounts representing interest.
(2) Represents long-term debt payment provided holders of the Convertible Senior Notes due 2014 do not exercise the option to convert each
$1,000 note into 30.6279 shares of our common stock. Our Convertible Senior Notes are discussed further in Note 9 to our consolidated
financial statements contained in “Financial Statements and Supplementary Data.”
(3) Represents payments on the delayed draw term loan (Term Loan), which was used to fund the purchase of the Convertible Senior Notes.
Quarterly repayments of the original principal amount of the Term Loan are required under the Senior Credit Facility, with the remaining
principal amount due on February 10, 2016.
(4) Represents interest on Convertible Senior Notes due 2014 payable semiannually with an annual interest rate of 2.625%.
(5) Represents interest on the Term Loan, which bears interest at a one month London Interbank Offered Rate (LIBOR) rate, plus a margin based
on our consolidated leverage ratio as defined in the Senior Credit Facility. As of December 30, 2011, the one month LIBOR was 0.30% and
the applicable margin was 2.25%. This estimate is subject to uncertainty due to the variable nature of the interest rates. Should interest
rates vary significantly, our estimate could be materially different from actual results.
The amounts reflected in the table above for capital lease obligations represent future minimum lease payments under our capital lease
agreements, which are primarily for certain property and equipment. The present value of the minimum lease payments are recorded in our
balance sheet at December 31, 2011. The minimum lease payments related to these leases are discussed further in Note 9 to our consolidated
financial statements contained in “Financial Statements and Supplementary Data.”
The amounts reflected in the table above for operating leases represent future minimum lease payments under non-cancelable operating leases
primarily for certain equipment and office space. The royalty and consulting agreements in the above table represent minimum payments under
non-cancelable contracts with consultants that are contingent upon future services. Portions of these payments are denominated in foreign
currencies and were translated in the table above based on their respective U.S. dollar exchange rates at December 31, 2011. These future
payments are subject to foreign currency exchange rate risk. Our purchase obligations and royalty and consulting agreements are disclosed in
Note 18 to our consolidated financial statements contained in “Financial Statements and Supplementary Data.”
Portions of these payments are denominated in foreign currencies and were translated in the table above based on their respective U.S. dollar
exchange rates at December 31, 2011. These future payments are subject to foreign currency exchange rate risk. In accordance with U.S.
generally accepted accounting principles, our operating leases are not recognized in our consolidated balance sheet; however, the minimum
lease payments related to these agreements are disclosed in Note 18 to our consolidated financial statements contained in “Financial Statements
and Supplementary Data.”
Contingent consideration of up to $400,000 may be paid related to the acquisition of certain assets associated with the EZ Concept Surgical
Device Corporation (EZ Frame). The potential additional cash payments are based on the future financial performance of the acquired assets.
Additionally, in accordance with the October 2011 CCI acquisition, we will pay royalties based on sales of the acquired product.
In addition to the contractual cash obligations discussed above, all of our U.S. sales and a portion of our international sales are subject to
commissions based on net sales. A substantial portion of our global sales are subject to royalties earned based on product sales.
Additionally, as of December 31, 2011, we had $3.7 million of unrecognized tax benefits recorded within “Other liabilities” in our consolidated
balance sheet. This represents the tax benefits associated with various tax positions taken, or expected to be taken, on U.S. and international tax
returns that have not been recognized in our financial statements due to uncertainty regarding their resolution. We are unable to make a reliable
estimate of the eventual cash flows by period that may be required to settle these matters. Certain of these matters may not require cash
15
settlement due to the existence of net operating loss carryforwards. Therefore, our unrecognized tax benefits are not included in the table above.
See Note 12 to our consolidated financial statements contained in “Financial Statements and Supplementary Data.”
Other Liquidity Information. We have funded our cash needs since 2000 through various equity and debt issuances and through cash flow from
operations. In 2001, we completed our initial public offering of 7,500,000 shares of common stock, which generated $84.8 million in net
proceeds. In 2002, we completed a secondary offering of 3,450,000 shares of common stock, which generated $49.5 million in net proceeds. In
2007, we issued $200 million of 2.625% Convertible Senior Notes due 2014, which generated net proceeds totaling $193.5 million. In 2011, we
purchased $170.9 million aggregate principal amount of the notes outstanding which we funded through a delayed draw term loan of $150
million under our senior credit facility and cash on hand.
Although it is difficult for us to predict our future liquidity requirements, we believe that our current cash balance of approximately $153.6
million, our marketable securities balances totaling $18.1 million and available borrowings under the senior credit facility will be sufficient for the
foreseeable future to fund our working capital requirements and operations, permit anticipated capital expenditures in 2012 of approximately
$30 million, and meet our contractual cash obligations in 2012.
Critical Accounting Estimates
All of our significant accounting policies and estimates are described in Note 2 to our consolidated financial statements contained in “Financial
Statements and Supplementary Data.” Certain of our more critical accounting estimates require the application of significant judgment by
management in selecting the appropriate assumptions in determining the estimate. By their nature, these judgments are subject to an inherent
degree of uncertainty. We develop these judgments based on our historical experience, terms of existing contracts, our observance of trends in
the industry, information provided by our customers and information available from other outside sources, as appropriate. Different, reasonable
estimates could have been used in the current period. Additionally, changes in accounting estimates are reasonably likely to occur from period to
period. Both of these factors could have a material impact on the presentation of our financial condition, changes in financial condition or results
of operations.
We believe that the following financial estimates are both important to the portrayal of our financial condition and results of operations and
require subjective or complex judgments. Further, we believe that the items discussed below are properly recorded in the financial statements
for all periods presented. Our management has discussed the development, selection and disclosure of our most critical financial estimates with
the audit committee of our board of directors and with our independent auditors. The judgments about those financial estimates are based on
information available as of the date of the financial statements. Those financial estimates include:
Revenue recognition. Our revenues are primarily generated through two types of customers, hospitals and surgery centers and stocking
distributors, with the majority of our revenue derived from sales to hospitals. Our products are sold through a network of employee and
independent sales representatives in the U.S. and by a combination of employee sales representatives, independent sales representatives and
stocking distributors outside the U.S. We record revenues from sales to hospitals and surgery centers when they take title to the product, which is
generally when the product is surgically implanted in a patient.
We record revenues from sales to our stocking distributors at the time the product is shipped to the distributor. Our stocking distributors, who
sell the products to their customers, take title to the products and assume all risks of ownership. Our distributors are obligated to pay us within
specified terms regardless of when, if ever, they sell the products. In general, our distributors do not have any rights of return or exchange;
however, in limited situations we have repurchase agreements with certain stocking distributors. Those certain agreements require us to
repurchase a specified percentage of the inventory purchased by the distributor within a specified period of time prior to the expiration of the
contract. During those specified periods, we defer the applicable percentage of the sales. Approximately $0.2 million and $0.3 million of sales
related to these types of agreements were deferred and not yet recognized as revenue as of December 31, 2011 and 2010, respectively.
We must make estimates of potential future product returns related to current period product revenue. To do so, we analyze our historical
experience related to product returns when evaluating the adequacy of the allowance for sales returns. Judgment must be used and estimates
made in connection with establishing the allowance for product returns in any accounting period. Our allowances for product returns of
approximately $0.5 million and $0.6 million are included as a reduction of accounts receivable at December 31, 2011 and 2010, respectively.
Should actual future returns vary significantly from our historical averages, our operating results could be affected.
In 2011, we entered into a trademark license agreement (License Agreement) with KCI Medical Resources, a subsidiary of Kinetic Concepts, Inc
(KCI). In exchange for $8.5 million, of which $5.5 million was received immediately and $3 million was received in January 2012, the License
Agreement provides KCI with a non-transferable license to use our trademarks associated with our GRAFTJACKET® line of products in connection
with the marketing and distribution of KCI's soft tissue graft containment products used in the wound care field, subject to certain exceptions.
License revenue is being recognized over 12 years on a straight line basis.
Allowances for doubtful accounts. We experience credit losses on our accounts receivable and accordingly, we must make estimates related to
the ultimate collection of our accounts receivable. Specifically, we analyze our accounts receivable, historical bad debt experience, customer
concentrations, customer creditworthiness and current economic trends when evaluating the adequacy of our allowance for doubtful accounts.
The majority of our accounts receivable are from hospitals, many of which are government funded. Accordingly, our collection history with this
class of customer has been favorable. Historically, we have experienced minimal bad debts from our hospital customers and more significant bad
debts from certain international stocking distributors, typically as a result of specific financial difficulty or geo-political factors. We write off
accounts receivable when we determine that the accounts receivable are uncollectible, typically upon customer bankruptcy or the customer’s
non-response to continued collection efforts.
We believe that the amount included in our allowance for doubtful accounts has been a historically appropriate estimate of the amount of
accounts receivable that are ultimately not collected. While we believe that our allowance for doubtful accounts is adequate, the financial
condition of our customers and the geo-political factors that impact reimbursement under individual countries’ healthcare systems can change
rapidly, which would necessitate additional allowances in future periods. Our allowances for doubtful accounts were $8.5 million and $9.5
million, at December 31, 2011 and 2010, respectively, which includes a $0.6 million provision recorded in 2011, a $1.1 million provision recorded
16
in 2010, and a $5.6 million provision recorded in 2009 for potential losses related to the trade receivable balances of certain of our non-U.S.
stocking distributors.
Excess and obsolete inventories. We value our inventory at the lower of the actual cost to purchase and/or manufacture the inventory on a first-
in, first-out (FIFO) basis or its net realizable value. We regularly review inventory quantities on hand for excess and obsolete inventory and, when
circumstances indicate, we incur charges to write down inventories to their net realizable value. Our review of inventory for excess and obsolete
quantities is based primarily on our forecast of product demand and production requirements for the next 24 months. A significant decrease in
demand could result in an increase in the amount of excess inventory quantities on hand. Additionally, our industry is characterized by regular
new product development that could result in an increase in the amount of obsolete inventory quantities on hand due to cannibalization of
existing products. Also, our estimates of future product demand may prove to be inaccurate in which case we may be required to incur charges
for excess and obsolete inventory. In the future, if additional inventory write-downs are required, we would recognize additional cost of goods
sold at the time of such determination. Regardless of changes in our estimates of future product demand, we do not increase the value of our
inventory above its adjusted cost basis. Therefore, although we make every effort to ensure the accuracy of our forecasts of future product
demand, significant unanticipated decreases in demand or technological developments could have a significant impact on the value of our
inventory and our reported operating results.
Charges incurred for excess and obsolete inventory were $16.7 million, $9.3 million and $12.5 million for the years ended December 31, 2011,
2010 and 2009, respectively.
Additionally, in 2011, we recorded charges of $2.5 million associated with product optimization in connection with our previously announced
plans to implement a cost restructuring plan to foster growth, enhance profitability and cash flow, and build stockholder value.
Goodwill and long-lived assets. We have approximately $57.9 million of goodwill recorded as a result of the acquisition of businesses. Goodwill
is tested for impairment annually, or more frequently if changes in circumstances or the occurrence of events suggest that impairment exists.
Based on our single business approach to decision-making, planning and resource allocation, we have determined that we have only one
reporting unit for purposes of evaluating goodwill for impairment. The annual evaluation of goodwill impairment may require the use of
estimates and assumptions to determine the fair value of our reporting unit using projections of future cash flows. We performed our annual
impairment test during the fourth quarter of 2011 and determined that the fair value of our reporting unit exceeded its carrying value and,
therefore, no impairment charge was necessary.
Our business is capital intensive, particularly as it relates to surgical instrumentation. We depreciate our property, plant and equipment and
amortize our intangible assets based upon our estimate of the respective asset’s useful life. Our estimate of the useful life of an asset requires us
to make judgments about future events, such as product life cycles, new product development, product cannibalization and technological
obsolescence, as well as other competitive factors beyond our control. We account for the impairment of definite, long-lived assets in accordance
with the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Section 360, Property, Plant and Equipment (FASB
ASC 360). Accordingly, we evaluate impairments of our property, plant and equipment based upon an analysis of estimated undiscounted future
cash flows. If we determine that a change is required in the useful life of an asset, future depreciation and amortization is adjusted accordingly.
Alternatively, if we determine that an asset has been impaired, an adjustment would be charged to income based on the asset’s fair market value,
or discounted cash flows if the fair market value is not readily determinable, reducing income in that period.
Product liability claims and other litigation. Periodically, claims arise involving the use of our products. We make provisions for claims
specifically identified for which we believe the likelihood of an unfavorable outcome is probable and an estimate of the amount of loss has been
developed. As additional information becomes available, we reassess the estimated liability related to our pending claims and make revisions as
necessary. In the third quarter of 2011, as a result of an increase in the number and monetary amount of claims associated with fractures of our
long PROFEMUR® titanium modular necks, management recorded a provision for current and future claims associated with fractures of this
product. See Note 18 to our consolidated financial statements for further description of this provision. Future revisions in our estimates of the
liability could materially impact our results of operation and financial position. We maintain insurance coverage that limits the severity of any
single claim as well as total amounts incurred per policy year, and we believe our insurance coverage is adequate. We use the best information
available to us in determining the level of accrued product liabilities, and we believe our accruals are adequate. Our accrual for product liability
claims at December 31, 2011 was $23.7 million, of which $23.3 million was for our accrual related to long PROFEMUR® titanium modular necks in
North America. We maintain insurance coverage that limits our self-insured risk per policy year, and have recorded an estimate of the probable
recovery related to open claims. The estimated insurance proceeds are for current and projected claims through the end of our current coverage
period, which ends in August 2012. Our accrual for product liability claims was $1.8 million at December 31, 2010.
We are also involved in legal proceedings involving contract, patent protection and other matters. We make provisions for claims specifically
identified for which we believe the likelihood of an unfavorable outcome is probable and an estimate of the amount of loss can be developed.
Accounting for income taxes. Our effective tax rate is based on income by tax jurisdiction, statutory rates and tax saving initiatives available to us
in the various jurisdictions in which we operate. Significant judgment is required in determining our effective tax rate and evaluating our tax
positions. This process includes assessing temporary differences resulting from differing recognition of items for income tax and accounting
purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. Realization of
deferred tax assets in each taxable jurisdiction is dependent on our ability to generate future taxable income sufficient to realize the benefits.
Management evaluates deferred tax assets on an ongoing basis and provides valuation allowances to reduce net deferred tax assets to the
amount that is more likely than not to be realized.
Our valuation allowance balances totaled $14.3 million and $14.9 million as of December 31, 2011 and 2010, respectively, due to uncertainties
related to our ability to realize, before expiration, some of our deferred tax assets for both U.S. and foreign income tax purposes. These deferred
tax assets primarily consist of the carryforward of certain tax basis net operating losses and general business tax credits.
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), effective January 1, 2007, which
requires the tax effects of an income tax position to be recognized only if they are “more-likely-than-not” to be sustained based solely on the
technical merits as of the reporting date. Effective July 1, 2009, this standard was incorporated into FASB ASC Section 740, Income Taxes. As a
17
multinational corporation, we are subject to taxation in many jurisdictions and the calculation of our tax liabilities involves dealing with
uncertainties in the application of complex tax laws and regulations in various taxing jurisdictions. If we ultimately determine that the payment
of these liabilities will be unnecessary, we will reverse the liability and recognize a tax benefit in the period in which we determine the liability no
longer applies. Conversely, we record additional tax charges in a period in which we determine that a recorded tax liability is less than we expect
the ultimate assessment to be. Our liability for unrecognized tax benefits totaled $3.7 million and $3.2 million as of December 31, 2011 and 2010,
respectively. See Note 12 to our consolidated financial statements contained in “Financial Statements and Supplementary Data” for further
discussion of our unrecognized tax benefits.
We operate within numerous taxing jurisdictions. We are subject to regulatory review or audit in virtually all of those jurisdictions, and those
reviews and audits may require extended periods of time to resolve. Management makes use of all available information and makes reasoned
judgments regarding matters requiring interpretation in establishing tax expense, liabilities and reserves. We believe adequate provisions exist
for income taxes for all periods and jurisdictions subject to review or audit.
Stock-based compensation. We calculate the grant date fair value of non-vested shares as the closing sales price on the trading day immediately
prior to the grant date. We use the Black-Scholes option pricing model to determine the fair value of stock options and employee stock purchase
plan shares. The determination of the fair value of these stock-based payment awards on the date of grant using an option-pricing model is
affected by our stock price as well as assumptions regarding a number of complex and subjective variables, which include the expected life of the
award, the expected stock price volatility over the expected life of the awards, expected dividend yield and risk-free interest rate.
We estimate the expected life of options evaluating the historical activity as required by FASB ASC Topic 718, Compensation — Stock
Compensation. We estimate the expected stock price volatility based upon historical volatility of our common stock. The risk-free interest rate is
determined using U.S. Treasury rates where the term is consistent with the expected life of the stock options. Expected dividend yield is not
considered as we have never paid dividends and have no plans of doing so in the future.
The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and
are fully transferable, characteristics not present in our option grants and employee stock purchase plan shares. Existing valuation models,
including the Black-Scholes and lattice binomial models, may not provide reliable measures of the fair values of our stock-based compensation.
Consequently, there is a risk that our estimates of the fair values of our stock-based compensation awards on the grant dates may bear little
resemblance to the actual values realized upon the exercise, expiration, early termination or forfeiture of those stock-based payments in the
future. Certain stock-based payments, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as
compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized
from these instruments that is significantly higher than the fair values originally estimated on the grant date and reported in our financial
statements. There is not currently a market-based mechanism or other practical application to verify the reliability and accuracy of the estimates
stemming from these valuation models.
We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those
estimates. We use historical data to estimate pre-vesting forfeitures and record stock-based compensation expense only for those awards that
are expected to vest. All stock-based awards are amortized on a straight-line basis over their respective requisite service periods, which are
generally the vesting periods.
If factors change and we employ different assumptions for estimating stock-based compensation expense in future periods, such stock-based
compensation expense in future periods may differ significantly from what we have recorded in the current period and could materially affect
our operating income, net income and net income per share. A change in assumptions may also result in a lack of comparability with other
companies that use different models, methods and assumptions.
See Note 15 to our consolidated financial statements contained in “Financial Statements and Supplementary Data” for further information
regarding our stock-based compensation disclosures.
Acquisition method accounting. Effective January 1, 2009, we adopted the provisions of Statement of Financial Accounting Standards No. 141R,
Business Combinations, which significantly changes the accounting for acquired businesses. Effective July 1, 2009, this standard was incorporated
into FASB ASC Section 805, Business Combinations (FASB ASC 805). Under this standard, an acquiring entity is required to recognize all assets
acquired and liabilities assumed at the acquisition date fair value. Legal fees and other transaction-related costs are expensed as incurred and are
no longer included in goodwill as a cost of acquiring the business. FASB ASC 805 also requires, among other things, acquirers to estimate the
acquisition-date fair value of any contingent consideration and to recognize any subsequent changes in the fair value of contingent
consideration in earnings. In addition, restructuring costs the acquirer expected, but was not obligated to incur, will be recognized separately
from the business acquisition. See Note 3 to our consolidated financial statements contained in "Financial Statements and Supplementary Data"
for information regarding our acquisitions.
Restructuring charges. We evaluate impairment issues for long-lived assets under the provisions of FASB ASC 360. We record severance-related
expenses once they are both probable and estimable in accordance with the provisions of FASB ASC Section 712, Compensation-Nonretirement
Postemployment Benefits, for severance provided under an ongoing benefit arrangement. One-time termination benefit arrangements and other
costs associated with exit activities are accounted for under the provisions of FASB ASC Section 420, Exit or Disposal Cost Obligations. We
estimated the expense for our restructuring initiatives by accumulating detailed estimates of costs, including the estimated costs of employee
severance and related termination benefits, impairment of property, plant and equipment, contract termination payments for leases and any
other qualifying exit costs. Such costs represented management’s best estimates, which were evaluated periodically to determine if an
adjustment was required.
Recent Accounting Pronouncements
The FASB has issued several Accounting Standards Updates (ASU) that will be effective in 2012. New guidance on fair value measurements (ASU
2011-04) and on presentation of other comprehensive income (ASU 2011-05) will not have a significant impact on our consolidated financial
statements.
18
Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
Our exposure to interest rate risk arises principally from the interest rates associated with our invested cash balances. On December 31, 2011, we
have invested short term cash and cash equivalents and marketable securities of approximately $55 million. We believe that a 25 basis point
change in interest rates is reasonably possible in the near term. Based on our current level of investment, an increase or decrease of 25 basis
points in interest rates would have an annual impact of $138,000 to our interest income.
We also are exposed to interest rate risk related to our U.S. dollar LIBOR-indexed borrowings of $144.4 million. We have entered into an interest
rate swap instrument to manage our earnings and cash flow exposure to changes in interest rates. This interest rate derivative instrument will fix
the interest rate on a portion ($50 million) of our LIBOR-indexed floating-rate borrowings.
Based on our outstanding borrowings at December 31, 2011, a 10% change in interest rates would have impacted the interest expense on the
unhedged portion of our debt by an immaterial amount on an annualized basis.
Foreign Currency Exchange Rate Fluctuations
Fluctuations in the rate of exchange between the U.S. dollar and foreign currencies could adversely affect our financial results. Approximately
31% and 29% of our total net sales were denominated in foreign currencies during the years ended December 31, 2011 and 2010, and we expect
that foreign currencies will continue to represent a similarly significant percentage of our net sales in the future. Cost of sales related to these
sales are primarily denominated in U.S. dollars; however, operating costs related to these sales are largely denominated in the same respective
currencies, thereby partially limiting our transaction risk exposure.
A substantial majority of our sales denominated in foreign currencies are derived from European Union countries, which are denominated in the
euro; from Japan, which are denominated in the Japanese yen; from the United Kingdom, which are denominated in the British pound; and from
Canada, which are denominated in the Canadian dollar. Additionally, we have significant intercompany receivables from our foreign subsidiaries
which are denominated in foreign currencies, principally the euro, the yen, the British pound, and the Canadian dollar. Our principal exchange
rate risk, therefore, exists between the U.S. dollar and the euro, the U.S. dollar and the yen, the U.S. dollar and the British pound, and the U.S.
dollar and the Canadian dollar. Fluctuations from the beginning to the end of any given reporting period result in the revaluation of our foreign
currency-denominated intercompany receivables and payables, generating currency translation gains or losses that impact our non-operating
income and expense levels in the respective period.
As discussed in Note 2 to our consolidated financial statements in “Financial Statements and Supplementary Data,” we enter into certain short-
term derivative financial instruments in the form of foreign currency forward contracts. These forward contracts are designed to mitigate our
exposure to currency fluctuations in our intercompany balances denominated in euros, Japanese yen, British pounds and Canadian dollars. Any
change in the fair value of these forward contracts as a result of a fluctuation in a currency exchange rate is expected to be offset by a change in
the value of the intercompany balance. These contracts are effectively closed at the end of each reporting period.
At December 31, 2011, the result of a uniform 10% strengthening in the value of the U. S. dollar relative to the currencies in which our
transactions are denominated would result in a decrease in operating income of approximately $8 million for 2011. This hypothetical calculation
assumes that each exchange rate would change in the same direction relative to the U.S. dollar. This sensitivity analysis of the effects of changes
in foreign currency exchange rates does not factor in a potential change in sales levels or local currency prices, which can be also be affected by
the change in exchange rates.
Other
We do not purchase or hold any market risk instruments for trading purposes.
19
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Wright Medical Group, Inc.:
We have audited the accompanying consolidated balance sheets of Wright Medical Group, Inc. and subsidiaries (the Company) as of December 31, 2011
and 2010, and the related consolidated statements of operations, changes in stockholders’ equity and comprehensive income, and cash flows for each of
the years in the three-year period ended December 31, 2011. These consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of
December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2011, in
conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal
control over financial reporting as of December 31, 2011, based on criteria established in Internal Control — Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 23, 2012 expressed an unqualified opinion on the
effectiveness of the Company’s internal control over financial reporting.
Memphis, Tennessee
February 23, 2012
20
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Wright Medical Group, Inc.:
We have audited the effectiveness of internal control over financial reporting of Wright Medical Group, Inc. and subsidiaries (the Company) as of
December 31, 2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal
Control Over Financial Reporting. Our responsibility is to express an opinion on the effectiveness of the Company’s internal control over financial reporting
based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing
such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company’s internal
control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on
criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance
sheets of the Company as of December 31, 2011 and 2010, and the related consolidated statements of operations, changes in stockholders’ equity and
comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2011, and our report dated February 23, 2012
expressed an unqualified opinion on those consolidated financial statements.
Memphis, Tennessee
February 23, 2012
21
Wright Medical Group, Inc.
Consolidated Balance Sheets (In thousands, except share data)
Assets:
Current assets:
Cash and cash equivalents
Marketable securities
Accounts receivable, net
Inventories
Prepaid expenses
Deferred income taxes
Other current assets
Total current assets
Property, plant and equipment, net
Goodwill
Intangible assets, net
Marketable securities
Deferred income taxes
Other assets
Total assets
Liabilities and Stockholders’ Equity:
Current liabilities:
Accounts payable
Accrued expenses and other current liabilities
Current portion of long-term obligations
Total current liabilities
Long-term debt and capital lease obligations
Deferred income taxes
Other liabilities
Total liabilities
Commitments and contingencies (Note 18)
Stockholders’ equity:
Common stock, $.01 par value, authorized: 100,000,000 shares; issued and outstanding: 39,306,118 shares at
December 31, 2011 and 39,171,501 shares at December 31, 2010
Additional paid-in capital
Accumulated other comprehensive income
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity
December 31,
2011
December 31,
2010
$
153,642 $
13,597
98,995
164,600
5,916
40,756
23,027
500,533
160,284
57,920
17,731
4,502
3,688
9,922
$
754,580 $
$
11,651 $
55,831
8,508
75,990
166,792
11,589
31,745
286,116
384
395,840
19,061
53,179
468,464
$
754,580 $
153,261
19,152
105,336
166,339
5,333
32,026
16,143
497,590
158,247
54,172
16,501
17,193
4,125
7,411
755,239
15,862
54,409
1,033
71,304
201,766
5,705
5,492
284,267
379
390,098
22,173
58,322
470,972
755,239
The accompanying notes are an integral part of these consolidated financial statements.
22
Wright Medical Group, Inc.
Consolidated Statements of Operations (In thousands, except per share data)
Net sales
Cost of sales 1
Cost of sales - restructuring
Gross profit
Operating expenses:
Selling, general and administrative 1
Research and development 1
Amortization of intangible assets
Restructuring charges (Note 17)
Total operating expenses
Operating income
Interest expense, net
Other expense, net
(Loss)income before income taxes
(Benefit)provision for income taxes
Net (loss)income
Net (loss)income per share (Note 13):
Basic
Diluted
Weighted-average number of shares outstanding-basic
$
$
$
$
Year ended December 31,
2011
2010
2009
512,947
156,906
2,471
353,570
301,588
30,114
2,870
14,405
348,977
4,593
6,529
4,719
(6,655 )
(1,512 )
518,973 $
158,456
—
360,517
282,413
37,300
2,711
919
323,343
37,174
6,123
130
30,921
13,080
(5,143 ) $
17,841 $
(0.13 ) $
(0.13 ) $
38,279
38,279
0.47 $
0.47 $
37,802
37,961
487,508
148,715
—
338,793
270,456
35,691
5,151
3,544
314,842
23,951
5,466
2,873
15,612
3,481
12,131
0.32
0.32
37,366
37,443
Weighted-average number of shares outstanding-diluted
___________________________
1
These line items include the following amounts of non-cash, stock-based compensation expense for the periods indicated:
Cost of sales
Selling, general and administrative
Research and development
Year Ended December 31,
2011
2010
2009
$
1,412 $
7,028
668
1,301 $
9,924
1,952
1,285
10,077
1,829
The accompanying notes are an integral part of these consolidated financial statements.
23
Wright Medical Group, Inc.
Consolidated Statements of Cash Flows (In thousands)
Operating activities:
Net (loss) income
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
Stock-based compensation expense
Amortization of intangible assets
Amortization of deferred financing costs
Deferred income taxes
Write off of deferred financing costs
Non-cash write-off of cumulative translation adjustment (CTA) balances
Excess tax benefit from stock-based compensation arrangements
Provision for losses on accounts receivable
Non-cash restructuring charges
Other
Changes in assets and liabilities (net of acquisitions):
Accounts receivable
Inventories
Prepaid expenses and other current assets
Accounts payable
Accrued expenses and other liabilities
Net cash provided by operating activities
Investing activities:
Capital expenditures
Acquisition of businesses
Purchase of intangible assets
Maturities of held-to-maturity marketable securities
Investment in held-to-maturity marketable securities
Sales and maturities of available-for-sale marketable securities
Investment in available-for-sale marketable securities
Proceeds from sale of assets
Net cash used in investing activities
Financing activities:
Issuance of common stock
Financing under factoring agreement, net
Payments of long term borrowings
Redemption of convertible senior notes
Proceeds from long term borrowings
Payments of deferred financing costs
Excess tax benefit from stock-based compensation arrangements
Net cash (used in) provided by financing activities
Effect of exchange rates on cash and cash equivalents
Net increase (decrease) in cash and cash equivalents
Year Ended December 31,
2011
2010
2009
$
(5,143 ) $
17,841 $
12,131
40,227
9,108
2,870
982
(6,969 )
2,926
—
(23 )
(453 )
4,924
1,102
9,056
(1,723 )
(10,556 )
(6,398 )
21,511
61,441
(46,957 )
(5,639 )
(1,624 )
4,748
—
38,509
(25,097 )
5,500
(30,560 )
540
—
(6,832 )
(170,889 )
150,000
(2,892 )
23
(30,050 )
(450 )
381
35,559
13,177
2,711
1,060
9,244
—
—
(289 )
1,073
246
624
(4,666 )
(1,754 )
(5,094 )
1,970
1,492
73,194
(49,038 )
(2,923 )
(1,690 )
—
(4,671 )
135,219
(81,070 )
—
(4,173 )
663
—
(1,150 )
—
—
—
289
(198 )
29
32,717
13,191
5,151
983
(9,247 )
—
2,643
(63 )
5,339
—
832
(4,003 )
13,049
5,953
(1,950 )
(4,975 )
71,751
(37,190 )
(6,785 )
(1,037 )
—
—
71,499
(101,443 )
—
(74,956 )
680
(58 )
(153 )
—
—
—
63
532
(783 )
68,852
(3,456 )
Cash and cash equivalents, beginning of year
153,261
84,409
87,865
Cash and cash equivalents, end of year
$
153,642 $
153,261 $
84,409
The accompanying notes are an integral part of these consolidated financial statements.
24
Wright Medical Group, Inc.
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income
For the Years Ended December 31, 2009, 2010 and 2011(In thousands, except share data)
Common Stock, Voting
Number of
Shares
Amount
Additional
Paid-in Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income
Total
Stockholders'
Equity
Balance at December 31, 2008
38,021,961 $
372 $
364,594 $
28,350 $
18,312 $
411,628
2009 Activity:
Net income
Foreign currency translation
Unrealized loss on marketable securities
Minimum pension liability adjustment
Total comprehensive loss
Write-off of cumulative translation adjustment
(CTA) balances
Issuances of common stock
—
—
—
—
—
64,446
Grant of non-vested shares of common stock
718,010
Cancellation of non-vested shares of common
stock
(147,971 )
—
—
—
—
—
—
—
—
—
—
—
—
—
680
—
—
12,131
—
—
—
—
—
—
—
Vesting of stock-settled phantom stock units
and non-vested shares of common stock
12,436
2
(2 )
—
Tax benefits (deficits) realized from stock
based compensation arrangements
Stock-based compensation
—
—
—
—
(1,892 )
13,267
—
—
—
2,398
(438 )
(9 )
2,643
—
—
—
—
—
—
12,131
2,398
(438 )
(9 )
14,082
2,643
680
—
—
—
(1,892 )
13,267
Balance at December 31, 2009
38,668,882 $
374 $
376,647 $
40,481 $
22,906 $
440,408
2010 Activity:
Net income
Foreign currency translation
Unrealized gain on marketable securities
Minimum pension liability adjustment
Total comprehensive income
Issuances of common stock
—
—
—
—
79,976
Grant of non-vested shares of common stock
504,999
Cancellation of non-vested shares of common
stock
(110,540 )
—
—
—
—
1
—
—
—
—
—
—
662
—
—
17,841
—
—
—
—
—
—
Vesting of stock-settled phantom stock units
and non-vested shares of common stock
28,184
4
(4 )
—
—
(826 )
75
18
—
—
—
—
17,841
(826 )
75
18
17,108
663
—
—
—
Tax benefits (deficits) realized from stock
based compensation arrangements
Stock-based compensation
—
— $
—
(424 )
— $
13,217 $
—
— $
—
(424 )
— $
13,217
Balance at December 31, 2010
39,171,501 $
379 $
390,098 $
58,322 $
22,173 $
470,972
25
Wright Medical Group, Inc.
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income
For the Years Ended December 31, 2009, 2010 and 2011(In thousands, except share data)
Common Stock, Voting
Number of
Shares
Amount
Additional
Paid-in Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income
Total
Stockholders'
Equity
2011 Activity:
Net loss
Foreign currency translation
Unrealized loss on derivative instruments, net
of $600 taxes
Unrealized loss on marketable securities
Minimum pension liability adjustment
Total comprehensive loss
Issuances of common stock
—
—
—
—
—
45,518
Grant of non-vested shares of common stock
403,084
Cancellation of non-vested shares of common
stock
(354,774 )
Vesting of stock-settled phantom stock units
and non-vested shares of common stock
Tax benefits (deficits) realized from stock
based compensation arrangements
Stock-based compensation
40,789
—
—
—
—
—
—
—
1
—
—
4
—
—
—
—
—
—
—
539
—
—
(4 )
(3,869 )
9,076
(5,143 )
—
—
—
—
—
—
—
—
—
—
—
(2,102 )
(5,143 )
(2,102 )
(1,014 )
(1,014 )
(33 )
37
—
—
—
—
—
—
(33 )
37
(8,255 )
540
—
—
—
(3,869 )
9,076
Balance at December 31, 2011
39,306,118 $
384 $
395,840 $
53,179 $
19,061 $
468,464
The accompanying notes are an integral part of these consolidated financial statements.
26
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
1. Organization and Description of Business
Wright Medical Group, Inc., through Wright Medical Technology, Inc. and other operating subsidiaries (Wright), is a global orthopaedic medical device
company specializing in the design, manufacture and marketing of devices and biologic products for extremity, hip and knee repair and reconstruction.
We are a leading provider of surgical solutions for the foot and ankle market. Our products are sold primarily through a network of employee sales
representatives and independent sales representatives in the United States (U.S.) and by a combination of employee sales representatives, independent
sales representatives and stocking distributors outside the U.S. We promote our products in approximately 60 countries with principal markets in the U.S.,
Europe, Canada, Australia and Japan. We are headquartered in Arlington, Tennessee.
2. Summary of Significant Accounting Policies
Principles of Consolidation. The accompanying consolidated financial statements include our accounts and those of our wholly owned U.S. and
international subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those
estimates. The most significant areas requiring the use of management estimates relate to revenue recognition, the determination of allowances for
doubtful accounts and excess and obsolete inventories, the evaluation of goodwill and long-lived assets, product liability claims and other litigation,
income taxes, stock-based compensation, accounting for business combinations, and accounting for restructuring charges.
Cash and Cash Equivalents. Cash and cash equivalents include all cash balances and short-term investments with original maturities of three months or less.
Inventories. Our inventories are valued at the lower of cost or market on a first-in, first-out (FIFO) basis. Inventory costs include material, labor costs and
manufacturing overhead. We regularly review inventory quantities on hand for excess and obsolete inventory and, when circumstances indicate, we incur
charges to write down inventories to their net realizable value. Our review of inventory for excess and obsolete quantities is based primarily on our
estimated forecast of product demand and production requirements for the next twenty-four months. Charges incurred to write down excess and
obsolete inventory to net realizable value included in “Cost of sales” were approximately $16.7 million, $9.3 million, and $12.5 million for the years ended
December 31, 2011, 2010, and 2009, respectively.
Additionally, in 2011, we recorded charges of approximately $2.5 million associated with the cost restructuring announced in the third quarter of 2011 for
the reduction of the size of our international product portfolio.
Product Liability Claims and Other Litigation. In the third quarter of 2011, as a result of an increase in the number of claims associated with fractures of our
long PROFEMUR® titanium modular necks in North America and an increase in the monetary amount of those claims, management recorded a provision for
current and future claims associated with fractures of this product. See Note 18 for further description of this provision.
Future revisions in our estimates of these provisions could materially impact our results of operations and financial position. We maintain insurance
coverage that limits the severity of any single claim as well as total amounts incurred per policy year, and we believe our insurance coverage is adequate.
We use the best information available to us in determining the level of accrued product liabilities, and we believe our accruals are adequate.
We are also involved in legal proceedings involving other product liability claims and contract, patent protection and other matters. We make provisions
for claims specifically identified for which we believe the likelihood of an unfavorable outcome is probable and an estimate of the amount of loss can be
developed. We have recorded at least the minimum estimated liability related to those claims where a range of loss has been established. Our accrual for
product liability claims at December 31, 2011 was $23.7 million, of which $23.3 million was for our accrual related to long PROFEMUR® titanium modular
necks in North America. We maintain insurance coverage that limits our self-insured risk per policy year, and have recorded an estimate of the probable
recovery related to open claims. The estimated insurance proceeds are for current and projected claims through the end of our current coverage period,
which ends in August 2012. Our accrual for product liability claims was $1.8 million at December 31, 2010. We recognize legal fees as an expense in the
period incurred.
Property, Plant and Equipment. Our property, plant and equipment is stated at cost. Depreciation, which includes amortization of assets under capital lease,
is generally provided on a straight-line basis over the estimated useful lives generally based on the following categories:
Land improvements
Buildings
Machinery and equipment
Furniture, fixtures and office equipment
Surgical instruments
15
10
3
1
to 25 years
to 45 years
to 12 years
to 14 years
6 years
Expenditures for major renewals and betterments, including leasehold improvements, that extend the useful life of the assets are capitalized and
depreciated over the remaining life of the asset or lease term, if shorter. 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.
27
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
Intangible Assets and Goodwill. Goodwill is recognized for the excess of the purchase price over the fair value of net assets of businesses acquired. Goodwill
is required to be tested for impairment at least annually. Unless circumstances otherwise dictate, the annual impairment test is performed in the fourth
quarter. Accordingly, during the fourth quarter of 2011, we evaluated goodwill for impairment and determined that the fair value of our reporting unit
exceeded its carrying value, indicating that goodwill was not impaired. Based on our single business approach to decision-making, planning and resource
allocation, management has determined that we have only one reporting unit for purposes of evaluating goodwill for impairment.
Our intangible assets with estimable useful lives are amortized on a straight line basis over their respective estimated useful lives to their estimated
residual values This method of amortization approximates the expected future cash flow generated from their use. Definite lived intangibles are reviewed
for impairment in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Section 360, Property, Plant and
Equipment (FASB ASC 360). The weighted average amortization periods for completed technology, distribution channels, trademarks, licenses, customer
relationships and other intangible assets are 10 years, 10 years, 7 years, 11 years, 10 years and 6 years, respectively. The weighted average amortization
period of our intangible assets on a combined basis is 10 years. Additionally, we have three indefinite lived trademarks and one in-process research and
development (IPRD) intangible asset. These indefinite lived intangible assets are not amortized, but are instead tested for impairment at least annually in
accordance with the provisions of FASB ASC Section 350, Intangibles - Goodwill and Other.
Valuation of Long-Lived Assets. Management periodically evaluates carrying values of long-lived assets, including property, plant and equipment and
intangible assets, when events and circumstances indicate that these assets may have been impaired. We account for the impairment of long-lived assets
in accordance with FASB ASC 360. Accordingly, we evaluate impairment of our property, plant and equipment based upon an analysis of estimated
undiscounted future cash flows. If it is determined that a change is required in the useful life of an asset, future depreciation and amortization is adjusted
accordingly. Alternatively, should we determine that an asset is impaired, an adjustment would be charged to income based on the difference between
the asset’s fair market value and the asset's carrying value.
Allowances for Doubtful Accounts. We experience credit losses on our accounts receivable and, accordingly, we must make estimates related to the ultimate
collection of our accounts receivable. Specifically, management analyzes our accounts receivable, historical bad debt experience, customer concentrations,
customer credit-worthiness and current economic trends when evaluating the adequacy of our allowance for doubtful accounts.
The majority of our accounts receivable are from hospitals, many of which are government funded. Accordingly, our collection history with this class of
customer has been favorable. Historically, we have experienced minimal bad debts from our hospital customers and more significant bad debts from
certain international stocking distributors, typically as a result of specific financial difficulty or geo-political factors. We write off accounts receivable when
we determine that the accounts receivable are uncollectible, typically upon customer bankruptcy or the customer’s non-response to continued collection
efforts. Our allowance for doubtful accounts totaled $8.5 million and $9.5 million at December 31, 2011 and 2010, respectively, which includes a $0.6
million provision recorded in 2011 and $5.6 million recorded in 2009 for potential losses related to the trade receivable balance of our stocking distributor
in Turkey.
Concentration of Credit Risk. Financial instruments which potentially subject us to concentrations of credit risk consist principally of accounts receivable.
Management attempts to minimize credit risk by reviewing customers’ credit history before extending credit and by monitoring credit exposure on a
regular basis. An allowance for possible losses on accounts receivable is established based upon factors surrounding the credit risk of specific customers,
historical trends and other information. Collateral or other security is generally not required for accounts receivable. As of December 31, 2011 and 2010,
the balance due from our stocking distributor in Turkey was $6.8 million and $8.9 million, respectively. As of December 31, 2011 and 2010, we have
recorded an allowance for doubtful accounts of $6.2 million and $5.6 million, respectively, for potential losses related to the trade receivable.
In addition to the stocking distributor in Turkey, our next ten largest international stocking distributors have net trade receivable balances totaling
approximately $15.3 million as of December 31, 2011. It is at least reasonably possible that changes in global economic conditions and/or local operating
and economic conditions in the regions these distributors operate, or other factors, could affect the future realization of these accounts receivable
balances.
Concentrations of Supply of Raw Material. We rely on a limited number of suppliers for the components used in our products. Our reconstructive joint
devices are produced from various surgical grades of titanium, cobalt chrome, stainless steel, various grades of high density polyethylenes, and ceramics.
We rely on one source to supply us with a certain grade of cobalt chrome alloy and one supplier for the silicone elastomer used in some of our extremity
products, and one supplier of ceramics for use in our hip products. For certain human biologic products, we depend on one supplier of demineralized
bone matrix (DBM) and cancellous bone matrix (CBM). We rely on one supplier for our GRAFTJACKET® family of soft tissue repair and graft containment
products, and one supplier for our xenograph bone wedge product. Porcine biologic soft tissue graft, BIOTAPE® XM relies on a single source supplier as
well. We maintain adequate stock from these suppliers in order to meet market demand.
Income Taxes. Income taxes are accounted for pursuant to the provisions of FASB ASC Section 740, Income Taxes (FASB ASC 740). Our effective tax rate is
based on income by tax jurisdiction, statutory rates and tax saving initiatives available to us in the various jurisdictions in which we operate. Significant
judgment is required in determining our effective tax rate and evaluating our tax positions. This process includes assessing temporary differences resulting
from differing recognition of items for income tax and financial accounting purposes. These differences result in deferred tax assets and liabilities, which
are included within our consolidated balance sheet. The measurement of deferred tax assets is reduced by a valuation allowance if, based upon available
evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
We provide for unrecognized tax benefits based upon our assessment of whether a tax position is “more-likely-than-not” to be sustained upon
examination by the tax authorities. If a tax position meets the more-likely-than-not standard, then the related tax benefit is measured based on a
cumulative probability analysis of the amount that is more-likely-than-not to be realized upon ultimate settlement or disposition of the underlying tax
position.
Other Taxes. Taxes assessed by a governmental authority that are imposed concurrent with our revenue transactions with customers are presented on a
net basis in our consolidated statement of operations.
28
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
Revenue Recognition. Our revenues are primarily generated through two types of customers, hospitals and surgery centers, and stocking distributors, with
the majority of our revenue derived from sales to hospitals. Our products are primarily sold through a network of employee sales representatives and
independent sales representatives in the U.S. and by a combination of employee sales representatives, independent sales representatives, and stocking
distributors outside the U.S. Revenues from sales to hospitals are recorded when the hospital takes title to the product, which is generally when the
product is surgically implanted in a patient.
We record revenues from sales to our stocking distributors outside the U.S. at the time the product is shipped to the distributor. Stocking distributors, who
sell the products to their customers, take title to the products and assume all risks of ownership. Our distributors are obligated to pay within specified
terms regardless of when, if ever, they sell the products. In general, the distributors do not have any rights of return or exchange; however, in limited
situations we have repurchase agreements with certain stocking distributors. Those certain agreements require us to repurchase a specified percentage of
the inventory purchased by the distributor within a specified period of time prior to the expiration of the contract. During those specified periods, we defer
the applicable percentage of the sales. Approximately $0.2 million and $0.3 million of deferred revenue related to these types of agreements was recorded
at December 31, 2011 and 2010, respectively.
We must make estimates of potential future product returns related to current period product revenue. We develop these estimates by analyzing historical
experience related to product returns. Judgment must be used and estimates made in connection with establishing the allowance for sales returns in any
accounting period. An allowance for sales returns of $0.5 million and $0.6 million is included as a reduction of accounts receivable at December 31, 2011
and 2010, respectively.
In 2011, we entered into a trademark license agreement (License Agreement) with KCI Medical Resources, a subsidiary of Kinetic Concepts, Inc (KCI). In
exchange for $8.5 million, of which $5.5 million was received immediately and the remaining $3 million was received in January 2012, the License
Agreement provides KCI with a non-transferable license to use our trademarks associated with our GRAFTJACKET® line of products in connection with the
marketing and distribution of KCI's soft tissue graft containment products used in the wound care field, subject to certain exceptions. License revenue is
being recognized over 12 years on a straight line basis.
Shipping and Handling Costs. We incur shipping and handling costs associated with the shipment of goods to customers, independent distributors and our
subsidiaries. Amounts billed to customers for shipping and handling of products are included in net sales. Costs incurred related to shipping and handling
of products are included in cost of sales. All other shipping and handling costs are included in selling, general and administrative expenses.
Research and Development Costs. Research and development costs are charged to expense as incurred.
Foreign Currency Translation. The financial statements of our international subsidiaries whose functional currency is the local currency are translated into
U.S. dollars using the exchange rate at the balance sheet date for assets and liabilities and the weighted average exchange rate for the applicable period
for revenues, expenses, gains and losses. Translation adjustments are recorded as a separate component of comprehensive income in stockholders’ equity.
Gains and losses resulting from transactions denominated in a currency other than the local functional currency are included in “Other expense, net” in our
consolidated statement of operations.
In accordance with FASB ASC Section 830, Foreign Currency Matters, we are required to recognize the cumulative translation adjustment (CTA) balance
from stockholders’ equity upon the complete or substantially complete liquidation of a foreign subsidiary. During 2009, we wrote-off approximately $2.6
million from the CTA balance for the substantially complete liquidation of two of our French subsidiaries and our subsidiary in Spain. This net cumulative
foreign currency loss is included in “Other expense, net” in our consolidated statements of operations.
Pension Benefits. Our subsidiary in Japan provides benefits to employees under a plan that we account for as a defined benefit plan in accordance with
FASB ASC Section 715, Compensation — Retirement Benefits. This plan is unfunded and determining the minimum pension liability requires the use of
assumptions and estimates, including discount rates and mortality rates, and actuarial methods. Our minimum pension liability totaled $2.3 million and
$2.2 million as of December 31, 2011 and 2010, respectively.
Comprehensive Income. Comprehensive income is defined as the change in equity during a period related to transactions and other events and
circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and
distributions to owners. The difference between our net income and our comprehensive income is attributable to foreign currency translation, unrealized
gains and losses (net of taxes) on our derivative instrument, adjustments to our minimum pension liability, and unrealized gains and losses on our
available-for-sale marketable securities.
Stock-Based Compensation. We account for stock-based compensation in accordance with FASB ASC Section 718, Compensation — Stock Compensation
(FASB ASC 718). Under the fair value recognition provisions of FASB ASC 718, stock-based compensation cost is measured at the grant date based on the
fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period. The
determination of the fair value of stock-based payment awards, such as options, on the date of grant using an option-pricing model is affected by our
stock price, as well as assumptions regarding a number of complex and subjective variables, which include the expected life of the award, the expected
stock price volatility over the expected life of the awards, expected dividend yield and risk-free interest rate.
We recorded stock-based compensation expense of $9.1 million for the year ended December 31, 2011, and $13.2 million during both of the years ended
2010 and 2009. See Note 15 for further information regarding our stock-based compensation assumptions and expenses.
Fair Value of Financial Instruments. The carrying value of cash and cash equivalents, accounts receivable and accounts payable approximates the fair value
of these financial instruments at December 31, 2011 and 2010 due to their short maturities or variable rates.
The carrying amount of debt outstanding pursuant to our credit facility approximates fair value as interest rates on these instruments approximate current
market rates. See Note 9 for additional information regarding the credit facility.
The $29.1 million of our convertible senior notes are carried at cost. The estimated fair value of the senior notes was approximately $27 million at
December 31, 2011 based on a limited number of trades and does not necessarily represent the value at which the entire convertible note portfolio can be
retired.
29
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
FASB ASC Section 820, Fair Value Measurements and Disclosures requires fair value measurements be classified and disclosed in one of the following three
categories:
Level 1:
Financial instruments with unadjusted, quoted prices listed on active market exchanges.
Level 2:
Level 3:
Financial instruments determined using prices for recently traded financial instruments with similar underlying terms as
well as directly or indirectly observable inputs, such as interest rates and yield curves that are observable at commonly
quoted intervals.
Financial instruments that are not actively traded on a market exchange. This category includes situations where there is
little, if any, market activity for the financial instrument. The prices are determined using significant unobservable inputs
or valuation techniques.
We use a third-party provider to determine fair values of our available-for-sale marketable securities. The third-party provider receives market prices for
each marketable security from a variety of industry standard data providers, security master files from large financial institutions and other third-party
sources with reasonable levels of price transparency. The third-party provider uses these multiple prices as inputs into a pricing model to determine a
weighted average price for each security. We classify our U.S. Treasury bills and bonds as Level 1 based upon quoted prices in active markets. All other
marketable securities are classified as Level 2 based upon the other than quoted prices with observable market data. These include municipal debt
securities, U.S agency debt securities, corporate debt securities, certificates of deposits and time deposits.
During the quarter ended March 31, 2011, we corrected an immaterial error in the footnotes to our 2010 Form 10-K related to the fair value hierarchy
classification of certain available-for-sale marketable securities. As of December 31, 2010, municipal debt securities, U.S. agency debt securities, and
corporate debt securities with fair values of $0.9 million, $14.5 million, and $3.2 million, respectively, all of which are Level 2 fair value measurements, were
incorrectly classified as Level 1 fair value measurements. The table below has been corrected to reflect the appropriate fair value hierarchy classification as
of December 31, 2010. This error is not considered material to the 2010 consolidated financial statements.
The following table summarizes the valuation of our financial instruments (in thousands):
At December 31, 2011
Assets
Cash and cash equivalents
Available-for-sale marketable securities
Municipal debt securities
U.S. agency debt securities
Corporate debt securities
Total available-for-sale marketable securities
Liabilities
Interest rate swap
Contingent consideration
Quoted Prices
in Active
Markets
(Level 1)
Prices with
Other
Observable
Inputs
(Level 2)
Prices with
Unobservable
Inputs
(Level 3)
Total
$
153,642 $
153,642 $
— $
508
2,498
15,093
18,099
—
—
—
—
508
2,498
15,093
18,099
$
171,741 $
153,642 $
18,099 $
1,662
1,704
—
—
1,662
—
$
3,366 $
— $
1,662 $
—
—
—
—
—
—
—
1,704
1,704
30
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
At December 31, 2010
Assets
Cash and cash equivalents
Available-for-sale marketable securities
Municipal debt securities
U.S. agency debt securities
Certificates of deposits
Corporate debt securities
U.S. government debt securities
Total available-for-sale marketable securities
Held-to-maturity time deposits
Liabilities
Contingent consideration
Quoted Prices
in Active
Markets
(Level 1)
Prices with
Other
Observable
Inputs
(Level 2)
Prices with
Unobservable
Inputs
(Level 3)
Total
$
153,261 $
153,261 $
— $
897
14,511
38
3,183
13,045
31,674
—
—
—
—
13,045
13,045
897
14,511
38
3,183
—
18,629
4,671
—
4,671
$
189,606 $
166,306 $
23,300 $
—
—
—
—
—
—
—
—
—
$
356
356 $
—
— $
—
— $
356
356
As part of the acquisition of EZ Concepts Surgical Device Corporation, d/b/a EZ Frame (EZ Frame acquisition), completed in 2010, we may be obligated to
pay contingent consideration of up to $0.4 million upon the achievement of certain revenue milestones. The $0.4 million fair value of the contingent
consideration as of the acquisition date was determined using a discounted cash flow model and probability adjusted estimates of the future earnings and
is classified in Level 3. This obligation is included in current liabilities in our 2011 consolidated balance sheet. Changes in the fair value of contingent
consideration are recorded in our consolidated statements of operations.
As part of the acquisition of CCI® Evolution Mobile Bearing Total Ankle Replacement system (CCI acquisition), completed in 2011, we recorded a contingent
liability for royalty payments associated with future sales of this product. The $1.3 million fair value of the contingent consideration as of the acquisition
date was determined using a discounted cash flow model and probability adjusted estimates of the future revenues and is classified in Level 3. An
obligation of $0.1 million was recorded in current liabilities and an obligation of $1.2 million recorded in long term liabilities in our 2011 consolidated
balance sheet. Changes in the fair value of contingent consideration will be recorded in our consolidated statements of operations.
The $1.3 million increase in instruments with Level 3 valuations during 2011 is attributable to the contingent consideration associated with the CCI
acquisition in 2011, and a $15,000 loss recognized in earnings related to the change in fair value of the contingent consideration associated with the EZ
Frame acquisition.
Derivative Instruments. We account for derivative instruments and hedging activities under FASB ASC Section 815, Derivatives and Hedging (FASB ASC 815).
Accordingly, all of our derivative instruments are recorded in the accompanying consolidated balance sheets as either an asset or liability and measured at
fair value. The changes in the derivative’s fair value are recognized currently in earnings unless specific hedge accounting criteria are met.
We employ a derivative program using 30-day foreign currency forward contracts to mitigate the risk of currency fluctuations on our intercompany
receivable and payable balances that are denominated in foreign currencies. These forward contracts are expected to offset the transactional gains and
losses on the related intercompany balances. These forward contracts are not designated as hedging instruments under FASB ASC 815. Accordingly, the
changes in the fair value and the settlement of the contracts are recognized in the period incurred in the accompanying consolidated statements of
operations.
We recorded a net loss of $0.9 million, a net loss of $2.6 million and a net gain of $0.7 million for the years ended December 31, 2011, 2010 and 2009,
respectively, on foreign currency contracts, which are included in “Other expense, net” in our consolidated statements of operations. These losses
substantially offset translation gains recorded on our intercompany receivable and payable balances, also included in “Other expense, net.” At
December 31, 2011 and 2010, we had no foreign currency contracts outstanding.
Additionally, we entered into an interest rate swap to hedge a portion of our variable interest rate obligations. The interest rate swap has been accounted
for as a cash flow hedge in accordance with FASB ASC Topic 815. See Note 11 for further disclosure on our interest rate swap.
Reclassifications. Certain prior year amounts in the notes to consolidated financial statements have been reclassified to conform to the current year
presentation.
31
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
Supplemental Cash Flow Information. Cash paid for interest and income taxes was as follows (in thousands):
Interest
Income taxes
Year Ended December 31,
2011
2010
2009
$
$
6,162 $
7,006 $
5,524 $
6,670 $
5,492
10,419
In 2011 and 2010, we entered into capital leases of approximately $0.2 million and $2.5 million, respectively. We entered into insignificant amounts of
capital leases during 2009.
Recent Accounting Pronouncements. The FASB has issued several Accounting Standards Updates (ASU) that will be effective in 2012. New guidance on fair
value measurements (ASU 2011-04) and on presentation of other comprehensive income (ASU 2011-05) will not have a significant impact on our
consolidated financial statements.
3. Acquisitions
On October 26, 2011, we completed the acquisition of certain assets of the patented CCI® Evolution Mobile Bearing Total Ankle Replacement system with
Van Straten Medical B.V. The purchase consideration consists of a cash payment of $5.6 million and a contingent liability of $1.3 million for estimated
future royalty payments. The estimated royalties payments are based on future sales; therefore, we cannot estimate the total amount of contingent
consideration that will be paid.
The operating results from this acquisition are included in the consolidated financial statements from the acquisition date.
The acquisition was recorded by allocating the costs of the assets acquired based on their estimated fair values at the acquisition date. The excess of the
cost of the acquisition over the fair value of the assets acquired is recorded as goodwill. The following is a summary of the estimated fair values of the
assets acquired (in thousands):
Inventory
Property, plant and equipment
Intangible assets
Total assets acquired
$
$
388
149
6,435
6,972
Of the $6.4 million recognized as intangible assets, $0.1 million was assigned to trademarks (indefinite life), $1.8 million was assigned to completed
technology (10 year life), $0.5 million was assigned to other intangible assets (7 year life), and $4.0 million to goodwill. We expect the total amount of
goodwill from this transaction to be deductible for tax purposes.
4. Inventories
Inventories consist of the following (in thousands):
Raw materials
Work-in-process
Finished goods
5. Marketable Securities
December 31,
2011
2010
$
8,860 $
19,363
136,377
$
164,600 $
8,962
24,723
132,654
166,339
We have historically invested in treasury bills, government and agency bonds, and certificates of deposit with maturity dates of less than 12 months. Our
investments in these marketable securities are classified as available-for-sale securities in accordance with FASB ASC Topic 320, Investments — Debt and
Equity Securities. These securities are carried at their fair value, and all unrealized gains and losses are recorded within other comprehensive income. In the
third quarter of 2010, we invested in a bank deposit with an initial maturity date of 12 months. This investment was classified as held-to-maturity at
December 31, 2010 and carried at its amortized cost. Marketable securities are classified as current for those expected to mature or be sold within 12
months and the remaining portion is classified as non-current. The cost of investment securities sold is determined by the specific identification method.
As of December 31, 2011 and 2010, we had current marketable securities totaling $13.6 million and $19.2 million, respectively, consisting of investments in
treasury bills, government, municipal and agency bonds, corporate bonds, and certificates of deposits, all of which are valued at fair value using a market
approach. In addition, we had noncurrent marketable securities totaling $4.5 million and $17.2 million as of December 31, 2011 and 2010, consisting of
investments in municipal, agency, and corporate bonds, all of which are valued at fair value using a market approach.
32
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
The following tables present a summary of our marketable securities (in thousands):
$
$
$
At December 31, 2011
Available-for-sale marketable securities
Municipal debt securities
U.S. agency debt securities
Corporate debt securities
Total available-for-sale marketable securities
At December 31, 2010
Available-for-sale marketable securities
Municipal debt securities
U.S. agency debt securities
Certificates of deposits
Corporate debt securities
U.S. government debt securities
Total available-for-sale marketable securities
Held-to-maturity time deposits
Total marketable securities
The maturities of available-for-sale securities at December 31, 2011 are as follows:
Due in one year or less
Due after one year through two years
6. Property, Plant and Equipment
Property, plant and equipment consists of the following (in thousands):
Land and land improvements
Buildings
Machinery and equipment
Furniture, fixtures and office equipment
Construction in progress
Surgical instruments
Less: Accumulated depreciation
33
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Estimated
Fair Value
$
$
507 $
2,500
15,089
18,096 $
1 $
—
4
5 $
— $
(2 )
—
(2 ) $
508
2,498
15,093
18,099
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Estimated
Fair Value
$
897 $
14,501
38
3,176
13,027
31,639 $
— $
11
—
7
18
36 $
— $
(1 )
—
—
—
(1 ) $
897
14,511
38
3,183
13,045
31,674
4,671 $
— $
— $
4,671
36,310 $
36 $
(1 ) $
36,345
Available-for-Sale
Cost Basis
Fair Value
$
$
13,592 $
4,504
18,096 $
13,597
4,502
18,099
December 31,
2011
2010
$
5,628 $
30,543
74,878
57,299
7,553
177,104
353,005
(192,721 )
5,469
30,024
68,401
42,584
13,887
162,781
323,146
(164,899 )
$
160,284 $
158,247
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
The components of property, plant and equipment recorded under capital leases consist of the following (in thousands):
Machinery and equipment
Furniture, fixtures and office equipment
Less: Accumulated depreciation
December 31,
2011
2010
$
2,663 $
639
3,302
(593 )
$
2,709 $
2,853
405
3,258
(350 )
2,908
Depreciation expense approximated $40.2 million, $35.6 million, and $32.7 million for the years ended December 31, 2011, 2010, and 2009, respectively,
and included depreciation of assets under capital leases.
7. Goodwill and Intangibles
Changes in the carrying amount of goodwill occurring during the year ended December 31, 2011, are as follows (in thousands):
Goodwill at December 31, 2010
Goodwill associated with acquisition in 2011 (See Note 3)
Foreign currency translation
Goodwill at December 31, 2011
The components of our identifiable intangible assets are as follows (in thousands):
$
$
54,172
3,984
(236 )
57,920
Indefinite life intangibles
IPRD technology
Trademarks
Total indefinite life intangibles
Definite life intangibles
Distribution channels
Completed technology
Licenses
Customer relationships
Trademarks
Other
Total definite life intangibles
Total intangibles
Less: Accumulated amortization
Intangible assets, net
December 31, 2011
December 31, 2010
Cost
Accumulated
Amortization
Cost
Accumulated
Amortization
$
278
1,658
1,936
$
278
1,533
1,811
20,057
4,416
2,478
1,476
818
1,882
31,127
21,096 $
10,976
5,721
3,888
1,336
3,905
46,922 $
48,858
(31,127 )
20,563
6,162
2,040
1,087
633
1,426
31,911
20,719 $
12,349
5,613
3,888
1,173
2,859
46,601 $
48,412
(31,911 )
$
17,731
$
16,501
Based on the intangible assets held at December 31, 2011, we expect to amortize approximately $2.8 million in 2012, $2.4 million in 2013, $2.2 million in
2014, $2.2 million in 2015, and $2.0 million in 2016.
34
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
8. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consist of the following (in thousands):
Employee benefits
Royalties
Taxes other than income
Commissions
Professional and legal fees
Contingent consideration
Cost improvement restructuring liability (see Note 17)
Product liability
Other
9. Long-Term Debt and Capital Lease Obligations
Long-term debt and capital lease obligations consist of the following (in thousands):
Capital lease obligations
Term loan
Convertible Senior Notes
Less: current portion
December 31
2011
2010
$
$
10,233 $
6,887
6,076
5,230
7,355
481
1,948
6,377
11,244
55,831 $
11,469
5,755
4,785
6,892
7,992
356
—
1,766
15,394
54,409
December 31,
2011
December 31,
2010
$
1,814 $
144,375
29,111
175,300
(8,508 )
2,799
—
200,000
202,799
(1,033 )
$
166,792 $
201,766
In November 2007, we issued $200 million of 2.625% Convertible Senior Notes due 2014 (Notes). The Notes will mature on December 1, 2014. The Notes
pay interest semiannually at an annual rate of 2.625% and are convertible into shares of our common stock at an initial conversion rate of 30.6279 shares
per $1,000 principal amount of the Notes subject to adjustment upon the occurrence of specified events, which represents an initial conversion price of
$32.65 per share. The holder of the Notes may convert at any time on or prior to the close of business on the business day immediately preceding the
maturity date of Notes. Beginning on December 6, 2011, we may redeem the notes, in whole or in part, at a redemption price equal to 100% of the
principal amount of the Notes, plus accrued and unpaid interest, if the closing price of our common stock has exceeded 140% of the conversion price for at
least 20 days during any consecutive 30-day trading period. Additionally, if we experience a fundamental change event, as defined in the indenture
governing the Notes (Indenture), the holders may require us to purchase for cash all or a portion of the Notes, for 100% of the principal amount of the
notes, plus accrued and unpaid interest. If upon a fundamental change event, a holder elects to convert its Notes, we may, under certain circumstances,
increase the conversion rate for the Notes surrendered. The Notes are unsecured obligations and are effectively subordinated to (i) all of our existing and
future secured debt, including our obligations under our credit agreement, to the extent of the value of the assets securing such debt, and (ii) because the
Notes are not guaranteed by any of our subsidiaries, to all liabilities of our subsidiaries.
On February 10, 2011, we announced the commencement of a tender offer to purchase for cash any and all of our outstanding Notes. Upon expiration on
March 11, 2011, we purchased $170.9 million aggregate principal amount of the Notes. As a result of this transaction, we recognized approximately $4.1
million for the write off of pro-rata unamortized deferred financing fees and for bank and legal fees associated with the purchase. As of December 31, 2011,
$29.1 million aggregate principal amount of the Notes remain outstanding.
On February 10, 2011, we entered into an amended and restated revolving credit agreement (Senior Credit Facility). The Senior Credit Facility has revolver
availability of $200 million and availability in a delayed draw term loan of up to $150 million. The total availability can be increased by up to an additional
$100 million at our request and subject to the agreement of the lenders. Borrowings under the Senior Credit Facility will bear interest at the sum of a base
rate or a Eurodollar rate plus an applicable margin that ranges from 0.0% to 2.75%, depending on the type of loan and our consolidated leverage ratio. The
term of the Senior Credit Facility extends through February 10, 2016. As a result of this transaction, we incurred deferred financing charges of
approximately $2.9 million, which will be amortized over the term of the Senior Credit Facility.
In March 2011, to fund the purchase of the Notes, we borrowed $150 million under the delayed draw term loan (Term Loan) facility available under our
Senior Credit Facility. The Term Loan bears interest at a one month London Interbank Offered Rate (LIBOR) rate, plus a margin based on our consolidated
leverage ratio as defined in the Senior Credit Facility. As of December 30, 2011, the one month LIBOR was 0.30% and the applicable margin was 2.25%.
Quarterly repayments of the original principal amount of the Term Loan are required under the Senior Credit Facility, with the remaining principal amount
due on February 10, 2016.
35
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
Currently, the calculation of our leverage ratio in our Senior Credit facility agreement does not add back cash restructuring charges and expenses
associated with our DPA since its extension. In order to ensure compliance with our leverage ratio, it is possible that we may make an additional cash
payment of $30 million to $50 million to reduce our debt during 2012. Because the restructuring charges and DPA expenses will not have an ongoing
impact on our EBITDA calculation and debt covenant ratios, it is also possible that our Senior Credit facility will be amended to allow these charges as
addbacks and therefore, we would not need to make the additional principal payment described above. However, there can be no assurance the lender
will grant these additional modifications to the current debt agreement.
In March 2011, we entered into an interest rate swap agreement, which we designated as cash flow hedge of the underlying variable rate obligation on our
Term Loan. We did not have any interest rate swap agreements outstanding as of December 31, 2010. See Note 11 for additional information regarding the
interest rate swap agreement.
Aggregate annual maturities of our long-term obligations at December 31, 2011, excluding capital lease obligations, are as follows (in thousands):
2012
2013
2014
2015
2016
$
7,500
13,125
44,111
20,625
88,125
$
173,486
As discussed in Note 6, we have acquired certain property and equipment pursuant to capital leases. At December 31, 2011, future minimum lease
payments under capital lease obligations, together with the present value of the net minimum lease payments, are as follows (in thousands):
2012
2013
2014
2015
2016
Total minimum payments
Less amount representing interest
Present value of minimum lease payments
Current portion
Long-term portion
10. Other Long-Term Liabilities
Other long-term liabilities consist of the following (in thousands):
Unrecognized tax benefits (See Note 12)
Product liability (See Note 18)
Other
11. Derivative Instruments and Hedging Activities
$
$
1,080
849
18
3
—
1,950
(136 )
1,814
(1,008 )
806
December 31
2011
2010
$
3,688 $
17,273
10,784
$
31,745 $
3,221
—
2,271
5,492
We account for derivatives in accordance with FASB ASC 815, which establishes accounting and reporting standards requiring that derivative instruments
be recorded on the balance sheet as either an asset or liability measured at fair value. Additionally, changes in the derivative’s fair value shall be recognized
currently in earnings unless specific hedge accounting criteria are met. If hedge accounting criteria are met for cash flow hedges, the changes in a
derivative’s fair value are recorded in stockholders’ equity as a component of other comprehensive income, net of tax. These deferred gains and losses are
recognized in income in the period in which the hedge item and hedging instrument affect earnings.
Interest Rate Hedging
On March 14, 2011, we entered into an interest rate swap intended to hedge our variable interest rate obligations with respect to a portion of the our
Senior Credit Facility discussed in Note 9. This interest rate swap is a contract to exchange fixed rate payments for floating rate payments over the life of
36
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
the agreement without the exchange of the underlying notional amount. The notional amount of the interest rate swap is used to measure interest to be
paid or received and does not represent the amount of exposure to credit loss.
As of December 31, 2011, we had a $144.4 million loan outstanding under our Senior Credit Facility and one interest rate swap with a notional amount of
$50 million. Under the terms of the interest rate swap agreement, we receive interest on the $50 million notional amount based on one-month LIBOR and
we pay a fixed rate of 1.74%. This swap effectively converted $50 million of our variable-rate borrowings to fixed-rate borrowings beginning on March 31,
2011 and through February 27, 2015. The fair value of the interest rate swap as of December 31, 2011 was a liability of $1.7 million and is recorded within
"Other liabilities" in our consolidated balance sheet.
In accordance with FASB ASC 815, we designated the above interest rate swap as a cash flow hedge and formally documented the relationship between
the interest rate swap and the fixed rate borrowing, as well as our risk management objective and strategy for undertaking the hedge transaction. This
process included linking the derivative to the specific liability or asset on the balance sheet. We assessed whether the derivative used in the hedging
transaction was highly effective in offsetting changes in the cash flows of the hedged item at inception and will test both retrospectively and prospectively
on an ongoing basis. The effective portion of unrealized gains (losses) on the derivative instrument used in the hedging transaction will be deferred as a
component of accumulated other comprehensive income (AOCI) and will be recognized in earnings at the time the hedged item affects earnings. Any
ineffective portion of the change in fair value will be immediately recognized in earnings. At December 31, 2011, because there was no ineffective portion
of the interest rate swap, the total fair value of the liability was recorded to AOCI.
Counterparty Credit Risk
We manage our concentration of counterparty credit risk on our derivative instruments by limiting acceptable counterparties to major financial
institutions with investment grade credit ratings, and by actively monitoring their credit ratings on an on-going basis. Therefore, we consider the credit risk
of the counterparties to be low.
The following table summarizes the fair value and the presentation in the consolidated balance sheet as of December 31, 2011 (in thousands):
Interest rate swap
Interest rate swap
Derivatives not Designated as Hedging Instruments
Location on consolidated
balance sheet
December 31,
2011
Other liabilities
$
1,662
Amount of gain or (loss)
recognized in AOCI during the
year ended December 31,
2011
(Effective Portion)
$
(1,662 )
We employ a derivative program using 30-day foreign currency forward contracts to mitigate the risk of currency fluctuations on our intercompany
receivable and payable balances that are denominated in foreign currencies. These forward contracts are expected to offset the transactional gains and
losses on the related intercompany balances. These forward contracts are not designated as hedging instruments under FASB ASC 815. Accordingly, the
changes in the fair value and the settlement of the contracts are recognized in the period incurred in the accompanying consolidated statements of
operations. At December 31, 2011, we had no foreign currency contracts outstanding.
12. Income Taxes
The components of our income before income taxes are as follows (in thousands):
U.S.
Foreign
(Loss)Income before income taxes
Year Ended December 31,
2011
2010
2009
$
$
(15,738 ) $
9,083
(6,655 ) $
24,507 $
6,414
30,921 $
9,062
6,550
15,612
37
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
The components of our provision for income taxes are as follows (in thousands):
Current provision (benefit):
U.S.:
Federal
State
Foreign
Total current provision
Deferred (benefit) provision:
U.S.:
Federal
State
Foreign
Total deferred (benefit) provision
Total (benefit) provision for income taxes
Year Ended December 31,
2011
2010
2009
$
2,956 $
416
2,085
5,457
(11 ) $
1,160
2,687
3,836
(6,376 )
(1,141 )
548
(6,969 )
9,166
375
(297 )
9,244
$
(1,512 ) $
13,080 $
10,229
1,003
1,496
12,728
(8,203 )
(1,162 )
118
(9,247 )
3,481
A reconciliation of the statutory U.S. federal income tax rate to our effective income tax rate is as follows:
Income tax provision at statutory rate
State income taxes
Change in valuation allowance
Research and development credit
Foreign income tax rate differences
Non-deductible stock-based compensation expense
Other non-deductible expenses
Tax settlement
Other, net
Total
Year Ended December 31,
2011
2010
2009
35.0 %
10.3 %
(5.9 )%
8.3 %
4.5 %
(5.9 )%
(4.4 )%
(15.6 )%
(3.6 )%
22.7 %
35.0 %
4.0 %
1.8 %
(2.7 )%
(3.5 )%
2.0 %
5.3 %
— %
0.4 %
42.3 %
35.0 %
2.9 %
(6.0 )%
(4.2 )%
(9.8 )%
6.0 %
1.4 %
— %
(3.0 )%
22.3 %
The significant components of our deferred income taxes as of December 31, 2011 and 2010 are as follows (in thousands):
Deferred tax assets:
Net operating loss carryforwards
General business credit carryforward
Reserves and allowances
Stock-based compensation expense
Other
Valuation allowance
Total deferred tax assets
Deferred tax liabilities:
Depreciation
Intangible assets
Other
Total deferred tax liabilities
Net deferred tax assets
38
December 31,
2011
2010
$
21,759 $
1,892
40,623
6,456
7,840
(14,271 )
18,675
2,386
26,726
9,388
6,540
(14,897 )
64,299
48,818
23,734
2,675
5,029
15,037
2,481
866
31,438
18,384
$
32,861 $
30,434
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
Outside basis differences that have not been tax-effected in accordance with FASB ASC 740 are primarily related to undistributed earnings of certain of our
foreign subsidiaries. Deferred tax liabilities for U.S. federal income taxes are not provided on the undistributed earnings of our foreign subsidiaries that are
considered permanently reinvested. The determination of the amount of unrecognized deferred tax liabilities is not practicable.
At December 31, 2011, we had net operating loss carryforwards for U.S. federal income tax purposes of approximately $22.0 million, which begin to expire
in 2018. Additionally, we had general business credit carryforwards of approximately $1.9 million, which begin to expire in 2017 and extend through 2031.
At December 31, 2011, we had foreign net operating loss carryforwards of approximately $42.2 million, all of which do not expire.
Certain of our U.S. and foreign net operating losses and general business credit carryforwards are subject to various limitations. We maintain valuation
allowances for those net operating losses and tax credit carryforwards that we do not expect to utilize due to these limitations and it is more likely than not
that such tax benefits will not be realized.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
Balance at January 1, 2011
Additions for tax positions related to current year
Additions for tax positions of prior years
Reductions for tax positions of prior years
Settlements
Foreign currency translation
Balance at December 31, 2011
$
$
3,221
586
999
(469 )
(591 )
(58 )
3,688
During the year ended December 31, 2011, we received an assessment from the Internal Revenue Service related to our 2008 U.S. federal income tax
return, and recorded an increase to an uncertain tax position of approximately $0.5 million. As of December 31, 2011, our liability for unrecognized tax
benefits totaled $3.7 million and is recorded in our consolidated balance sheet within “Other liabilities,” and all components, if recognized, would impact
our effective tax rate. Our U.S. federal income taxes represent the substantial majority of our income taxes, and the Internal Revenue Service may begin
examination of our 2009 and 2010 U.S. federal income tax return. It is therefore possible that our unrecognized tax benefits could change in the next
twelve months.
We accrue interest required to be paid by the tax law for the underpayment of taxes on the difference between the amount claimed or expected to be
claimed on the tax return and the tax benefit recognized in the financial statements. Management has made the policy election to record this interest as
interest expense. As of December 31, 2011, accrued interest related to our unrecognized tax benefits totaled approximately $0.3 million which is recorded
in our consolidated balance sheet within “Other liabilities.”
We file numerous consolidated and separate company income tax returns in the U.S. and in many foreign jurisdictions. We are no longer subject to foreign
income tax examinations by tax authorities in significant jurisdictions for years before 2006. With few exceptions, we are subject to U.S. federal, state and
local income tax examinations for years 2008 through 2010. However, tax authorities have the ability to review years prior to these to the extent that we
utilize tax attributes carried forward from those prior years.
13. Earnings Per Share
FASB ASC Section 260, Earnings Per Share, requires the presentation of basic and diluted earnings per share. Basic earnings per share is calculated based on
the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is calculated to include any dilutive
effect of our common stock equivalents. Our common stock equivalents consist of stock options, non-vested shares of common stock, stock-settled
phantom stock units, restricted stock units, and convertible debt. The dilutive effect of the stock options, non-vested shares of common stock, stock-
settled phantom stock units, and restricted stock units is calculated using the treasury-stock method. The dilutive effect of convertible debt is calculated by
applying the “if-converted” method. This assumes an add-back of interest, net of income taxes, to net income as if the securities were converted at the
beginning of the period. We determined that for the years ended December 31, 2009, 2010, and 2011, the convertible debt had an anti-dilutive effect on
earnings per share and we therefore excluded it from the dilutive shares calculation. In addition, 136,000 common stock equivalents have been excluded
from the computation of diluted net loss per share for the year ended December 31, 2011, because the effect is anti-dilutive as a result of our net loss.
The weighted-average number of common shares outstanding for basic and diluted earnings per share purposes is as follows (in thousands):
Weighted-average number of common shares outstanding — basic
Common stock equivalents
Weighted-average number of common shares outstanding — diluted
Year Ended December 31,
2011
2010
2009
38,279
—
38,279
37,802
159
37,961
37,366
77
37,443
39
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
The following potential common shares were excluded from the computation of diluted earnings per share as their effect would have been anti-dilutive (in
thousands):
Stock options
Non-vested shares, restricted stock units, and stock-settled phantom stock units
Convertible debt
14. Capital Stock
Year Ended December 31,
2011
2010
2009
3,400
430
1,909
3,766
621
6,126
3,872
1,151
6,126
We are authorized to issue up to 100,000,000 shares of voting common stock. We have 60,693,882 shares of voting common stock available for future
issuance at December 31, 2011.
15. Stock-Based Compensation Plans
We have three stock-based compensation plans which are described below. Amounts recognized in the consolidated financial statements with respect to
these plans are as follows:
Total cost of share-based payment plans
Amounts capitalized as inventory and intangible assets
Amortization of capitalized amounts
Charged against income before income taxes
Amount of related income tax benefit recognized in income
Impact to net income
Impact to basic earnings per share
Impact to diluted earnings per share
Year Ended December 31,
2011
2010
2009
9,076 $
(1,392 )
1,424
9,108
(2,946 )
13,217 $
(1,353 )
1,313
13,177
(4,410 )
6,162 $
8,767 $
0.16 $
0.16 $
0.23 $
0.23 $
13,267
(1,361 )
1,285
13,191
(3,901 )
9,290
0.25
0.25
$
$
$
$
As of December 31, 2011, we had $15.8 million of total unrecognized compensation cost related to unvested stock-based compensation arrangements
granted to employees. That cost is expected to be recognized over a weighted-average period of 2.5 years.
Equity Incentive Plans.
On December 7, 1999, we adopted the 1999 Equity Incentive Plan, which was subsequently amended and restated on July 6, 2001, May 13, 2003, May 13,
2004, May 12, 2005 and May 14, 2008 and amended on October 23, 2008. The 1999 Equity Incentive Plan expired December 7, 2009. The 2009 Equity
Incentive Plan (the Plan) was adopted on May 13, 2009, which was subsequently amended and restated on May 13, 2010. The Plan authorizes us to grant
stock options and other stock-based awards, such as non-vested shares of common stock, with respect to up to 11,917,051 shares of common stock, of
which full value awards (such as non-vested shares) are limited to 2,729,555 shares. Under the plan, stock based compensation awards generally are
exercisable in increments of 25% annually on each of the first through fourth anniversaries of the date of grant. All of the options issued under the plan
expire after ten years. These awards are recognized on a straight-line basis over the requisite service period, which is generally four years. As of
December 31, 2011, there were 2,355,501 shares available for future issuance under the Plan, of which full value awards are limited to 560,974 shares.
Stock options
We estimate the fair value of stock options using the Black-Scholes valuation model. The Black-Scholes option-pricing model requires the input of
estimates, including the expected life of stock options, expected stock price volatility, the risk-free interest rate and the expected dividend yield. The
expected life of options is estimated based on historical option exercise and employee termination data. The expected stock price volatility assumption
was estimated based upon historical volatility of our common stock. The risk-free interest rate was determined using U.S. Treasury rates where the term is
consistent with the expected life of the stock options. Expected dividend yield is not considered as we have never paid dividends and have no plans of
doing so in the future. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures
differ from those estimates. We use historical data to estimate pre-vesting forfeitures and record stock-based compensation expense only for those awards
that are expected to vest. The fair value of stock options is amortized on a straight-line basis over the respective requisite service period, which is generally
the vesting period.
40
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
The weighted-average grant date fair value of stock options granted to employees in 2011, 2010, and 2009 was $5.97 per share, $7.11 per share, and $6.23
per share, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model using the
following assumptions:
Risk-free interest rate
Expected option life
Expected price volatility
A summary of our stock option activity during 2011 is as follows:
2011
1.0% - 2.0%
6 years
39 %
Year Ended December 31,
2010
2.1% - 2.2%
6 years
40 %
2009
2.1% - 2.6%
6 years
39 %
Outstanding at December 31, 2010
Granted
Exercised
Forfeited or expired
Outstanding at December 31, 2011
Weighted-
Average
Exercise
Price
Weighted-
Average
Remaining
Contractual Life
Aggregate
Intrinsic Value*
($000’s)
Shares
(000’s)
3,741 $
395
(20)
(1,356)
2,760 $
23.62
15.52
10.44
22.22
23.23
4.73 $
508
Exercisable at December 31, 2011
________________________________
* The aggregate intrinsic value is calculated as the difference between the market value of our common stock as of December 30, 2011, and the exercise
price of the shares. The market value as of December 30, 2011 is $16.50 per share, which is the closing sale price of our common stock reported for
transactions effected on the Nasdaq Global Select Market on December 30, 2011
2,153 $
24.79
3.65 $
95
The total intrinsic value of options exercised during 2011, 2010, and 2009 was $0.1 million, $0.6 million, and $0.4 million, respectively.
A summary of our stock options outstanding and exercisable at December 31, 2011, is as follows (shares in thousands):
Range of Exercise Prices
$4.00 — $16.00
$16.01 — $24.00
$24.01 — $35.87
Options Outstanding
Options Exercisable
Weighted-
Average
Remaining
Contractual Life
Weighted-
Average
Exercise Price
Number
Outstanding
Number
Exercisable
Weighted-
Average
Exercise Price
486
991
1,283
2,760
8.5 $
4.5
3.5
4.7 $
15.46
20.79
28.05
23.23
84 $
851
1,218
2,153 $
15.38
21.18
27.97
24.79
Non-vested shares and stock settled phantom stock units and restricted stock units
We calculate the grant date fair value of non-vested shares of common stock, stock settled phantom stock units and restricted stock units using the closing
sale prices on the trading day immediately prior to the grant date. We are required to estimate forfeitures at the time of grant and revise those estimates in
subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting forfeitures and record stock-based
compensation expense only for those awards that are expected to vest.
We granted 483,000, 588,000, and 786,000 non-vested shares of common stock, stock settled phantom stock units and restricted stock units to employees
with weighted-average grant-date fair values of $15.52 per share, $18.34 per share, and $15.57 per share during 2011, 2010, and 2009, respectively. The fair
value of these shares will be recognized on a straight-line basis over the respective requisite service period, which is generally the vesting period.
During 2011, 2010 and 2009, we granted certain independent distributors and other non-employees non-vested shares of common stock of 28,000, 5,000
and 18,000 shares at a weighted-average grant date fair values of $15.27 per share, $18.20 per share and $16.76 per share, respectively.
41
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
A summary of our non-vested shares of common stock activity during 2011 is as follows:
Non-vested at December 31, 2010
Granted
Vested
Forfeited
Weighted-
Average
Grant-Date
Fair Value
Aggregate
Intrinsic Value*
($000’s)
Shares
(000’s)
1,316 $
511
(420 )
(380 )
18.99
15.51
20.21
18.11
Non-vested at December 31, 2011
___________________
* The aggregate intrinsic value is calculated as the market value of our common stock as of December 30, 2011. The market value as of December 30,
1,027 $
17.08 $
16,950
2011 is $16.50 per share, which is the closing sale price of our common stock reported for transactions effected on the Nasdaq Global Select Market
on December 30, 2011.
The total fair value of shares vested during 2011, 2010 and 2009 was $6.9 million, $6.3 million and $4.1 million, respectively.
Inducement Stock Options. During 2011, we granted 610,000 stock options under an Inducement Stock Option agreement with an exercise price of $16.03
to induce Robert J. Palmisano to commence employment with us as our Chief Executive Officer. These options vest over a three-year service period. We
also granted 30,000 stock options with an exercise price of $18.33 to Julie Tracy, Senior Vice President, Chief Communications Officer, and 65,000 stock
options with an exercise price of $16.23 to James Lightman, Senior Vice President, General Counsel, and Secretary, under Inducement Stock Option
agreements. These options have substantially the same terms as grants made under the Plan. The grant date fair value of these options was $5.96, $6.82
and $6.13, respectively, which was calculated using the Black-Scholes option valuation model using the same assumptions as the stock options granted
under the Plan. As of December 31, 2011, all of the options were outstanding, none of which were exercisable, with a remaining contractual life of 10 years.
Employee Stock Purchase Plan. On May 30, 2002, our shareholders approved and adopted the 2002 Employee Stock Purchase Plan (the ESPP). The ESPP
authorizes us to issue up to 200,000 shares of common stock to our employees who work at least 20 hours per week. Under the ESPP, there are two six-
month plan periods during each calendar year, one beginning January 1 and ending on June 30, and the other beginning July 1 and ending on
December 31. Under the terms of the ESPP, employees can choose each plan period to have up to 5% of their annual base earnings, limited to $5,000,
withheld to purchase our common stock. The purchase price of the stock is 85% of the lower of its beginning-of-period or end-of-period market price.
Under the ESPP, we sold to employees approximately 26,000, 28,000, and 27,000 shares in 2011, 2010, and 2009, respectively, with weighted-average fair
values of $4.92, $5.41, and $5.76 per share, respectively. As of December 31, 2011, there were 42,843 shares available for future issuance under the ESPP.
During 2011, 2010, and 2009, we recorded nominal amounts of non-cash, stock-based compensation expense related to the ESPP.
In applying the Black-Scholes methodology to the purchase rights granted under the ESPP, we used the following assumptions:
Risk-free interest rate
Expected option life
Expected price volatility
16. Employee Benefit Plans
2011
0.3% - 0.4%
6 months
39 %
Year Ended December 31,
2010
0.6% - 0.9%
6 months
40 %
2009
0.9% - 1.1%
6 months
39 %
We sponsor a defined contribution plan under Section 401(k) of the Internal Revenue Code, which covers U.S. employees who are 21 years of age and over.
Under this plan, we match voluntary employee contributions at a rate of 100% for the first 2% of an employee’s annual compensation and at a rate of 50%
for the next 2% of an employee’s annual compensation. Employees vest in our contributions after three years of service. Our expense related to the plan
was $1.8 million in 2011 and 2010 and $1.6 million in 2009.
17. Restructuring
On September 15, 2011, we announced plans to implement a cost restructuring plan to foster growth, enhance profitability and cash flow, and build
stockholder value. We have implemented numerous initiatives to reduce spending, including streamlining select aspects of our international selling and
distribution operations, reducing the size of our product portfolio, adjusting plant operations to align with our volume and mix expectations and
rationalizing our research and development projects. In total, we reduced our workforce by approximately 80 employees, or 6%.
Management estimates that the pre-tax restructuring charges will total approximately $18 million to $25 million. We expect the remaining charges to be
recorded during the first half of 2012.
These charges consist of the following estimates:
•
•
$6 million to $7 million of severance and other termination benefits;
$6 million to $8 million of contract terminations;
42
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
•
•
•
$3 million of non-cash asset impairment charges;
$2.5 million to $4 million of excess and obsolete inventory;
$0.5 million to $3 million of other cash and non-cash charges.
Charges associated with the restructuring recognized during 2011, are presented in the following table. All of the following amounts were recognized
within “Restructuring charges” in our consolidated statement of operations, with the exception of the excess and obsolete inventory charges, which were
recognized within "Cost of sales - restructuring".
(in thousands)
Severance and other termination benefits
Contract terminations
Non-cash asset impairment charges
Excess and obsolete charges
Legal and professional fees
Other
Total restructuring charges
Year Ended
December 31, 2011
$
5,416
5,977
2,453
2,471
303
256
$
16,876
Activity in the Cost Improvement restructuring liability for the year ended December 31, 2011, is presented in the following table (in thousands):
Beginning balance
Charges:
Severance and other termination benefits
Contract terminations
Legal and professional fees
Other
Total Charges
Payments:
Severance and other termination benefits
Contract terminations
Legal and professional fees
Other
Total Payments
Changes in foreign currency translation
Cost Improvement restructuring liability at December 31, 2011
18. Commitments and Contingencies
$
—
5,416
5,977
303
256
11,952
(3,899 )
(5,729 )
(162 )
(78 )
(9,868 )
(136 )
1,948
$
Operating Leases. We lease certain equipment and office space under non-cancelable operating leases. Rental expense under operating leases
approximated $12.3 million, $11.3 million, and $11.0 million for the years ended December 31, 2011, 2010, and 2009, respectively. In addition, in 2011, as a
result of our restructuring efforts, we recorded approximately $0.4 million for terminations of operating leases. Future minimum payments, by year and in
the aggregate, under non-cancelable operating leases with initial or remaining lease terms of one year or more, are as follows at December 31, 2011 (in
thousands):
2012
2013
2014
2015
2016
Thereafter
$
8,754
5,626
2,376
453
321
398
$
17,928
43
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
Royalty and Consulting Agreements. We have entered into various royalty and other consulting agreements with third party consultants. We incurred
royalty and consulting expenses of $0.2 million during each of the years ended December 31, 2011, 2010, and 2009, under non-cancelable contracts with
minimum obligations that were contingent upon performance of services. The amounts in the table below represent minimum payments to consultants
that are contingent upon future performance services. These fees are accrued when it is deemed probable that the performance thresholds are met.
Future minimum payments under these agreements for which we have not recorded a liability are as follows at December 31, 2011 (in thousands):
2012
2013
2014
2015
2016
Thereafter
$
$
147
142
142
142
142
—
715
Purchase Obligations. We have entered into certain supply agreements for our products, which include minimum purchase obligations. During the years
ended December 31, 2011, 2010, and 2009, we paid approximately $7.7 million, $6.1 million, and $3.1 million, respectively, under those supply
agreements. At December 31, 2011, we have no further obligations of minimum purchases under those supply agreements.
Portions of our payments for operating leases, royalty and consulting agreements are denominated in foreign currencies and were translated in the tables
above based on their respective U.S. dollar exchange rates at December 31, 2011. These future payments are subject to foreign currency exchange rate
risk.
Governmental Inquiries. In December 2007, we received a subpoena from the United States Department of Justice (DOJ) through the United States
Attorney’s Office for the District of New Jersey (USAO) requesting documents for the period January 1998 through the present related to any consulting
and professional service agreements with orthopaedic surgeons in connection with hip or knee joint replacement procedures or products. This subpoena
was served shortly after several of our knee and hip competitors agreed with the DOJ to resolutions of similar investigations.
On September 29, 2010, our wholly-owned subsidiary, Wright Medical Technology, Inc. (WMT), entered into a 12-month Deferred Prosecution Agreement
(DPA) with the USAO and a Civil Settlement Agreement (CSA) with the United States. Under the DPA, the USAO filed a criminal complaint in the United
States District Court for the District of New Jersey charging WMT with conspiracy to commit violations of the Anti-Kickback Statute (42 U.S.C. § 1320a-7b)
during the years 2002 through 2007. The court deferred prosecution of the criminal complaint during the term of the DPA and the USAO agreed that if
WMT complied with the DPA's provisions, the USAO would seek dismissal of the criminal complaint.
Pursuant to the CSA, WMT settled civil and administrative claims relating to the matter for a payment of $7.9 million without any admission by WMT. In
conjunction with the CSA, WMT also entered into a five year Corporate Integrity Agreement (CIA) with the Office of the Inspector General of the United
States Department of Health and Human Services (OIG-HHS). Pursuant to the DPA, an independent monitor is reviewing and evaluating WMT’s compliance
with its obligations under the DPA. The DPA and the CIA were filed as Exhibits 10.3 and 10.2, respectively, to our current report on Form 8-K filed on
September 30, 2010. The DPA has also been posted to our website. Each of the DPA and the CIA could be modified by mutual consent of the parties
thereto.
As a result of the work of the independent monitor and WMT’s compliance program, the Board of Directors became aware of facts indicative of possible
compliance issues. At the direction of the Nominating, Compliance and Governance Committee of the Board of Directors of WMT’s parent, Wright Medical
Group, Inc. (WMGI), WMGI and WMT conducted an internal investigation with the assistance of outside counsel. The Board of Directors of WMGI received a
report from outside counsel.
On May 4, 2011, our wholly-owned subsidiary Wright Medical Technology, Inc. (WMT) provided written notice to the independent monitor and to the
United States Attorney's Office for the District of New Jersey (USAO) of credible evidence of serious wrongdoing, pursuant to a notification requirement in
paragraph 20 of the Deferred Prosecution Agreement (DPA). On May 5, 2011, WMT received a letter from the USAO pursuant to paragraph 50 of the DPA
stating that the USAO believed that WMT had knowingly and willfully breached material provisions of the DPA. The issues WMT is addressing relate to: (i)
42 U.S.C. § 1320a-7b(b) (also known as the “Anti-Kickback Statute”), specifically regarding certain employees' communications with a health care
professional for consulting opportunities in a manner not consistent with WMT's compliance policy; (ii) the violation of Paragraph 25 of the DPA due to the
communications with a healthcare professional noted above; and (iii) alleged violations of Paragraph 17 of the DPA due to WMT failure to provide
information to the Monitor in a timely manner.
In order to resolve these issues, WMT has implemented a number of remedial measures, including: (i) taking appropriate personnel actions; (ii) enhancing
its policies and employee training with respect to compliance with the requirements of paragraph 8 of the DPA, which requires all Company employees
and agents to report suspected legal and policy violations, and paragraph 25 of the DPA, which governs interactions with consultants on the terms of
consulting agreements and payment issues; (iii) reviewing its existing relationships with certain customers and taking appropriate further action where
necessary with respect to these relationships; and (iv) clarifying lines of responsibility for making payments to consultants. WMT continues to provide
ongoing employee training and to review its relationships with customers, and is developing a protocol for internal reporting and investigation of
allegations of misconduct relating to senior management.
On September 15, 2011, WMT reached an agreement with the USAO and the OIG-HHS under which WMT voluntarily agreed to extend the term of its DPA
for 12 months. As amended, the DPA will now expire on September 29, 2012. The USAO has agreed not to take any additional action regarding any breach
of the DPA referenced in the aforementioned May 5, 2011 letter from the USAO unless it finds, prior to September 29, 2012, that WMT has committed a
knowing, willful and uncured breach of a material provision of the DPA by its conduct after September 15, 2011 or by conduct before September 15, 2011
44
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
of which the independent monitor was not aware on that date. If WMT complies with all of the requirements of the amended DPA, the USAO will seek
dismissal of the pending criminal complaint. On September 15, 2011, WMT also agreed with the OIG-HHS to an amendment to the Corporate Integrity
Agreement (CIA) under which certain of WMT's substantive obligations under the CIA will now begin on September 29, 2012, when the amended DPA
monitoring period expires. The term of the CIA has not changed, and will expire as previously provided on September 29, 2015. In connection with such
amendment, the OIG-HHS informed WMT that it had no present intention, based on the information then known to it, to exercise its authority under
Paragraph 51 of the DPA to exclude Wright from participation in federal healthcare programs based on any breach referenced in the May 5 letter unless
the USAO were to take further action related to an alleged breach of the DPA by WMT.
The Company and the independent monitor continue their investigative activities pursuant to the DPA, and communications amongst WMT and the
independent monitor, and other governmental agencies are ongoing. We are unable to predict the ultimate outcome of these activities.
As previously disclosed, at the direction of the Company's Board of Directors, WMT has continued to implement compliance measures and to take steps to
enhance WMT's compliance environment. From time to time, WMT has provided, and may in the future provide, pursuant to Paragraph 20 of the DPA,
written notices to the independent monitor and the USAO of “credible evidence of violations of 21 U.S.C. § 331,” a strict liability provision of the federal
Food, Drug and Cosmetic Act (and any such notices have been and will be provided to the OIG-HHS). Paragraph 20 of the DPA requires WMT to provide
written notice to the independent monitor and the USAO of credible evidence of violations of any criminal statute, regardless of whether any such
violations are material. WMT has conducted a review of its clinical and regulatory affairs operations, and may conduct further reviews on an ongoing
periodic basis. Although circumstances may change, the Company intends to disclose in its future filings with the Securities and Exchange Commission
any additional occasions when WMT provides written notice under Paragraph 20 of the DPA or under the CIA only if such potential violation or violations,
or any consequences therefrom, are required to be reported under U.S. federal securities laws.
The DPA and CIA impose certain obligations on WMT to maintain compliance with U.S. healthcare laws, regulations and other requirements. Our failure to
do so could expose us to significant liability including, but not limited to, exclusion from federal healthcare program participation, including Medicaid and
Medicare, which would have a material adverse effect on our financial condition, results of operations and cash flows, potential prosecution, including
under the previously-filed criminal complaint, civil and criminal fines or penalties, and additional litigation cost and expense. A breach of the DPA or the
CIA could result in an event of default under the Senior Credit Facility, which in turn could result in an event of default under the Indenture.
In addition to the USAO and OIG-HHS, other governmental agencies, including state authorities, could conduct investigations or institute proceedings that
are not precluded by the terms of the settlements reflected in the DPA and the CIA. In addition, the settlement with the USAO and OIG-HHS could increase
our exposure to lawsuits by potential whistleblowers, including under the federal false claims acts, based on new theories or allegations arising from the
allegations made by the USAO. The costs of defending or resolving any such investigations or proceedings could have a material adverse effect on our
financial condition, results of operations and cash flows.
Patent Litigation. In 2011, Howmedica Osteonics Corp. (Howmedica) and Stryker Ireland, Ltd. (Stryker), each a subsidiary of Stryker Corporation, filed a
lawsuit against WMT in the United States District Court for the District of New Jersey (District Court) alleging that we infringed Howmedica and Stryker’s
U.S. Patent No. 6,475,243 related to our LINEAGE® Acetabular Cup System and DYNASTY® Acetabular Cup System. The lawsuit seeks an order of
infringement, injunctive relief, unspecified damages, and various other costs and relief and could impact a substantial portion of our knee product line. We
believe, however, that we have strong defenses against these claims and plan to vigorously defend this lawsuit. Management does not believe that the
outcome of this lawsuit will have a material adverse effect on our consolidated financial position or results of operations.
Product Liability. Claims for personal injury have been made against us associated with fractures of our PROFEMUR® titanium modular neck product. The
overall fracture rate for the product is low and the fractures appear, at least in part, to relate to patient demographics. Beginning in 2010, we began
offering a cobalt-chrome version of our PROFEMUR® modular neck, which has greater strength characteristics than the alternative titanium version.
Historically, we have reflected our liability for these claims as part of our standard product liability accruals on a case-by-case basis. However, during the
third quarter of 2011, as a result of an increase in the number and monetary amount of claims, management determined an estimate of our liability to
patients in North America who have previously required a revision following a fracture of a long PROFEMUR® titanium modular neck, or may require a
revision in the future. Management has estimated that this aggregate liability ranges from approximately $23 million to $35 million. Any claims associated
with this product outside of North America, or for any other products, will be managed as part of our standard product liability accruals.
Due to the uncertainty within our aggregate range of loss resulting from the estimation of the number of claims and related monetary payments, we have
recorded a liability of $23.3 million, which represents the low-end of our estimated aggregate range of loss. We have classified $6.0 million of this liability
as current in “Accrued expenses and other current liabilities” and $17.3 million as non-current in “Other liabilities” on our consolidated balance sheet. We
expect to pay the majority of these claims within the next 4 years. We maintain insurance coverage that limits our self-insured risk per policy year, and have
recorded an estimate of the probable recovery of approximately $3.7 million related to open claims within “Other current assets” and $4.7 million related
to open claims within "Other assets" on our consolidated balance sheet. The estimated insurance proceeds are for current and projected claims through
the end of our current coverage period, which ends in August 2012. As a result of the estimated insurance proceeds and the amount we had previously
recorded under our historical product liability accrual methodology, we recorded a provision of $13.2 million within "Selling, general and administrative
expenses" on our consolidated statements of operations during the quarter ended September 30, 2011, when we determined this liability.
We rely on significant estimates in determining our estimated liability for these claims, including the number of claims that we will receive and the amount
we will pay per claim. The actual number of claims that we receive and the amount we pay per claim may differ from our estimates. These differences could
result in further changes to our estimated liability, the impact of which cannot be estimated.
We have received a limited number of claims for personal injury associated with our metal-on-metal hip products. The number of claims have recently
increased, we believe due to the increasing negative publicity in the industry regarding metal-on-metal hip products. To date, our metal-on-metal hip
products have performed well clinically, and we intend to vigorously defend ourselves in these matters. We are currently accounting for these claims in
accordance with our standard product liability accrual methodology on a case by case basis. Management does not believe that the outcome of claims will
have a material adverse effect on our consolidated financial position or results of operations.
45
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
Employment Matters. In January and February 2012, three former employees, Cary Hagan, Frank Bono and Alicia Napoli, each filed separate lawsuits against
WMT in the Chancery Court of Shelby County, Tennessee, asserting claims for retaliatory discharge and breach of contract based upon his or her respective
Separation Pay Agreement. In addition, Mr. Bono and Ms. Napoli each asserted a claim for defamation related to the press release issued at the time of
their terminations and a wrongful discharge claim alleging violation of the Tennessee Public Protection Act. Mr. Hagan, Mr. Bono and Ms. Napoli each
claim that he or she is entitled to attorney fees in addition to other unspecified damages. We intend to vigorously defend each of these lawsuits. However,
since these lawsuits were filed very recently, we have not yet answered their complaints and are unable to assess the likelihood of an unfavorable outcome
or estimate a potential range of loss, if any, at this time.
Other. We have received claims from health care professionals following the termination of certain contractual arrangements. These matters are in the
early stages of evaluation and management is unable to estimate the cost, if any, of ultimately resolving these claims. Accordingly, no provisions have
been recorded in our financial statements related to these claims as of December 31, 2011.
In addition to those noted above, we are subject to various other legal proceedings, product liability claims, corporate governance, and other matters
which arise in the ordinary course of business. In the opinion of management, the amount of liability, if any, with respect to these matters, will not
materially affect our consolidated results of operations or financial position.
19. Segment Data
We have one reportable segment, orthopaedic products, which includes the design, manufacture and marketing of devices and biologic products for
extremity, hip, and knee repair and reconstruction. Our geographic regions consist of the United States, Europe (which includes the Middle East and Africa)
and Other (which principally represents Latin America, Asia, Australia and Canada). Long-lived assets are those assets located in each region. Revenues
attributed to each region are based on the location in which the products were sold.
Net sales of orthopaedic products by product line and information by geographic region are as follows (in thousands):
Net sales by product line:
Hip products
Knee products
Extremity products
Biologics products
Other
Total net sales
Net sales by geographic region:
United States
Europe
Other
Total
Operating (loss) income by geographic region:
United States
Europe
Other
Total
Long-lived assets:
United States
Europe
Other
Total
Year Ended December 31,
2011
2010
2009
$
173,201 $
123,988
135,476
69,409
10,873
176,687 $
128,854
124,490
79,231
9,711
$
512,947 $
518,973 $
167,869
122,178
107,375
79,120
10,966
487,508
$
295,944 $
100,739
116,264
309,983 $
102,431
106,559
$
512,947 $
518,973 $
299,587
102,379
85,542
487,508
$
$
(31,389 ) $
2,220
33,762
4,593 $
7,838 $
1,619
27,717
37,174 $
16,268
(11,683 )
19,366
23,951
December 31,
2011
2010
$
131,745 $
12,226
16,313
$
160,284 $
129,450
12,383
16,414
158,247
46
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
Our subsidiary in Japan represented approximately 13%, 11%, and 10% of our total net sales in 2011, 2010, and 2009, respectively. No other single foreign
country accounted for more than 10% of our total net sales during 2011, 2010, or 2009.
During 2011, our operating income included restructuring charges associated with the previously announced cost restructuring plan. During 2010 and
2009 our operating income included restructuring charges associated with the closure of our facility in Toulon, France, and the closure of our facility in
Creteil, France. Our U.S. region recognized $12.7 million, $0.7 million and $3.3 million of restructuring charges in 2011, 2010 and 2009, respectively, and
our European region recognized $4.2 million, $0.2 million, and $0.3 million of restructuring charges in 2011, 2010 and 2009, respectively. Additionally, in
2011, 2010 and 2009, our U.S. region recognized $12.9 million, $10.9 million and $7.8 million of charges related to the U.S. government inquiries,
respectively. In 2011, our U.S. region recognized $13.2 million of charges related to the recognition of management's estimate of our total liability for
claims associated with previous and estimated future fractures of our PROFEMUR® long neck in North America. In 2009, our European region recognized a
provision of $5.6 million related to the trade receivable balance of our stocking distributor in Turkey.
20. Quarterly Results of Operations (unaudited):
The following table presents a summary of our unaudited quarterly operating results for each of the four quarters in 2011 and 2010, respectively (in
thousands). This information was derived from unaudited interim financial statements that, in the opinion of management, have been prepared on a basis
consistent with the financial statements contained elsewhere in this filing and include all adjustments, consisting only of normal recurring adjustments,
necessary for a fair statement of such information when read in conjunction with our audited financial statements and related notes. The operating results
for any quarter are not necessarily indicative of results for any future period.
Net sales
Cost of sales
Cost of sales - restructuring
Gross profit
Operating expenses:
Selling, general and administrative
Research and development
Amortization of intangible assets
Restructuring charges
Total operating expenses
Operating income (loss)
Net income (loss)
Net income (loss) per share, basic
Net income(loss) per share, diluted
Net sales
Cost of sales
Gross profit
Operating expenses:
Selling, general and administrative
Research and development
Amortization of intangible assets
Restructuring charges
Total operating expenses
Operating income
Net (loss) income
Net (loss) income per share, basic
Net (loss) income per share, diluted
2011
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
135,386 $
38,768
—
132,505 $
41,504
—
118,184 $
36,185
1,900
96,618
91,001
80,099
126,872
40,449
571
85,852
74,825
9,207
690
—
70,821
7,807
677
—
83,581
6,769
721
12,132
84,722
11,896 $
79,305
11,696 $
103,203
(23,104 ) $
3,592 $
6,147 $
(16,045 ) $
0.09 $
0.09 $
0.16 $
0.16 $
(0.42 ) $
(0.42 ) $
72,361
6,331
782
2,273
81,747
4,105
1,163
0.03
0.03
2010
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
131,244 $
40,141
127,734 $
39,934
121,708 $
37,989
91,103
87,800
83,719
138,287
40,392
97,895
76,438
9,835
649
544
87,466
3,637 $
(525 ) $
(0.01 ) $
(0.01 ) $
67,774
9,784
634
461
78,653
9,147 $
4,847 $
0.13 $
0.13 $
64,877
8,779
708
134
74,498
9,221 $
4,650 $
0.12 $
0.12 $
73,324
8,902
720
(220 )
82,726
15,169
8,869
0.23
0.22
$
$
$
$
$
$
$
$
$
$
47
Notes to Consolidated Financial Statements
Wright Medical Group, Inc.
Our operating income in 2011 included charges related to the U.S. government inquiries, for which we recognized $2.2 million, $2.4 million, $5.0 million,
and $3.4 million during the first, second, third and fourth quarters of 2011, respectively. In addition, our operating income during the third and fourth
quarters of 2011 included $14.0 million and $2.8 million of restructuring charges related to our cost improvement measures and, in the third quarter of
2011, included $13.2 million of charges related to the recognition of management estimate of our total liability for claims associated with previous and
estimated future fractures of our PROFEMUR® long necks in North America. Net income in 2011 included the after-tax effect of these amounts and in the
first quarter of 2011, the after-tax effects of approximately $4.1 million of expenses recognized for the write off of pro-rata unamortized deferred financing
fees.
Our operating income in 2010 included charges related to the U.S. government inquiries and, in the fourth quarter of 2010, our DPA, for which we
recognized $8.1 million, $0.6 million, $0.9 million and $1.3 million during the first, second, third and fourth quarters of 2010, respectively. Net income in
2010 included the after-tax effect of these amounts.
48
Management’s Annual Report on Internal Control Over Financial Reporting
Evaluation of Disclosure Controls and Procedures
We have established disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934. Our
disclosure controls and procedures are designed to ensure that material information relating to us, including our consolidated subsidiaries, is made known
to our principal executive officer and principal financial officer by others within our organization. Under the supervision and with the participation of our
management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our disclosure
controls and procedures as of December 31, 2011 to ensure that the information required to be disclosed by us in the reports that we file or submit under
the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.
Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by
us in the reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our
principal executive officer and principal financial officer as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation,
our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2011.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Under the supervision and with the
participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness
of our internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control — Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, our management concluded that our
internal control over financial reporting was effective as of December 31, 2011. Our internal control over financial reporting as of December 31, 2011, has
been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which is included herein.
Changes in Internal Control Over Financial Reporting
During the three months ended December 31, 2011, there were no significant changes in our internal control over financial reporting that materially
affected, or that are reasonably likely to materially affect, our internal control over financial reporting.
49
Corporate Information
Transfer Agent and Registrar
American Stock Transfer & Trust Company, Inc. acts as transfer
agent and registrar for us and maintains all stockholder
records. Communications concerning stock holdings, lost
certificates, transfer of shares, duplicate mailings or changes of
address should be directed to:
Wright Medical Group, Inc.
c/o American Stock Transfer & Trust Company
6201 15th Avenue, Brooklyn, NY 11219
800.937.5449 info@amstock.com
Cash Dividend Policy
We have never declared or paid cash dividends on common
stock and do not anticipate a change in this policy in the
foreseeable future. We currently intend to retain any future
earnings for the operation and expansion of our business.
Stock Prices and Trading Data
Our common stock is traded on the Nasdaq Global Select
Market under the symbol “WMGI.” Stock price quotations are
available in the investor relations section of our website at
www.wmt.com and are printed daily in major newspapers,
including The Wall Street Journal.
The ranges of high and low sale prices per share for our
common stock for 2011 and 2010 are set forth below. Price
data reflect actual transactions. In all cases, the prices shown
are
reflect markups,
markdowns, or commissions.
inter-dealer prices and do not
Stockholders
As of February 16, 2012, there were 588 stockholders of
record. As of February 8, 2012, there were an estimated 4,641
beneficial owners of our common stock.
Index), and an
Comparison of Total Stockholder Returns
The graph below compares the cumulative total stockholder returns
for the period from December 31, 2006 to December 31, 2011, for
our common stock, an index composed of U.S. companies whose
stock is listed on the Nasdaq Global Select Market (the Nasdaq U.S.
Companies
index consisting of Nasdaq-listed
companies in the surgical, medical, and dental instruments and
supplies industry (the Nasdaq Medical Equipment Companies
Index). The graph assumes that $100.00 was
invested on
in our common stock, the Nasdaq U.S.
December 31, 2006,
Companies Index, and the Nasdaq Medical Equipment Companies
Index, and that all dividends were reinvested. Total returns for the
two Nasdaq indices are weighted based on the market capitalization
of the companies included therein. Historic stock price performance
is not indicative of future stock price performance. We do not make
or endorse any prediction as to future stock price performance.
Cumulative Total Stockholder Returns
Based on Reinvestment of $100.00 Beginning on December 31, 2006
Cumulative Total Stockholder Returns
Based on Reinvestment of $100.00 Beginning on December 31, 2006
Wright Medical Group, Inc.
Nasdaq U.S. Companies Index
Nasdaq Medical Equipment Companies Index
$
100.00 $
100.00
100.00
12/31/2006
12/31/2007
125.30 $
108.47
127.15
12/31/2008
12/31/2009
12/31/2010
87.77 $
66.35
68.47
81.38 $
95.38
99.85
66.72 $
113.19
106.48
12/31/2011
70.90
113.81
122.34
Copyright 2012 CRSP Center for Research in Security Prices, University of Chicago, Graduate School of
Business. Zacks Investment Research, Inc. Used with permission. All rights reserved.
Independent Auditors
KPMG LLP
Memphis, Tennessee
2011
High* Low*
$17.66
$17.35
$18.75
$19.05
$14.44
$14.05
$13.37
$13.57
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
*denotes high & low sale prices
2010
High* Low*
$19.25
$19.61
$17.70
$15.99
$15.72
$16.00
$13.03
$12.98
Non-GAAP Financial Measures
We use non-GAAP financial measures, such as gross profit, as adjusted, operating income, as adjusted, net income, as adjusted, net income, as adjusted, per diluted share, and
free cash flow. Our management believes that the presentation of these measures provides useful information to investors. These measures may assist investors in evaluating
our operations, period over period. The measures exclude such items as restructuring, non-cash stock based compensation expense, transaction costs and non-cash deferred
financing costs associated with the Convertible Notes tender offer, employee matters, product liability provision, non-cash inventory step amortization, IRS audit liability, all of
which may be highly variable, difficult to predict and of a size that could have substantial impact on our reported results of operations for a period. Free cash flow is calculated
by subtracting capital expenditures from cash provided by operating activities.
Management uses these measures internally for evaluation of the performance of the business, including the allocation of resources and the evaluation of results relative to
employee performance compensation targets. Investors should consider these non-GAAP measures only as a supplement to, not as a substitute for or as superior to, measures
of financial performance prepared in accordance with GAAP. This annual report includes discussion of non-GAAP financial measures. Reference is made to the most directly
comparable GAAP financial measures and the reconciliation of the differences between the two financial measures, which is found on page 1 of this annual report and is
otherwise available in the “Corporate - Investor Information - Supplemental Financial Information” section of our website located at www.wmt.com and in our Form 8-Ks filed on
February 23, 2012; February 10, 2011; February 18, 2010; February 19, 2009; and February 14, 2008.
50
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51
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52
Stockholder Information
Independent Auditors
KPMG LLP
Memphis, TN
Transfer Agent & Registrar
American Stock Transfer & Trust Company, Inc.
6201 15th Avenue, Brooklyn, NY 11219
718.921.8124
800.937.5449
info@amstock.com
Stock Information
Our common stock is traded on the
Nasdaq Global Select Market under
the symbol “WMGI.”
Investor & Media Inquiries
Julie Tracy
SVP, Chief Communications Offi cer
901.290.5817
julie.tracy@wmt.com
Annual Meeting
The annual meeting of our stockholders will
be held on May 9, 2012 beginning at 8:00 am
(Central Time) at:
Baker, Donelson, Bearman,
Caldwell & Berkowitz, PC
165 Madison Avenue, Suite 2000
Memphis, TN 38103
Senior Management
Directors
Robert J. Palmisano
President & Chief Executive Offi cer
Lance A. Berry
SVP, Chief Financial Offi cer
Timothy E. Davis
SVP, Corporate Development
Daniel J. Garen
SVP, Chief Compliance Offi cer
William L. Griffi n
SVP, Global Operations
James A. Lightman
SVP, General Counsel & Secretary
Edward A. Steiger
SVP, Human Resources
Eric A. Stookey
SVP, Chief Commercial Offi cer
Julie D. Tracy
SVP, Chief Communications Offi cer
Jennifer S. Walker
SVP, Process Improvement
Gary D. Blackford 1,3
President & Chief Executive Offi cer
Universal Hospital Services, Inc.
Director since 2008
Martin J. Emerson 1, 2
President & Chief Executive Offi cer
Galil Medical, Inc.
Director since 2006
Lawrence W. Hamilton 2*
Former SVP, Human Resources
Tech Data Corporation
Director since 2007
Ronald K. Labrum 2
Chief Executive Offi cer
FENWAL, Inc.
Director since 2011
John L. Miclot 3*
President & Chief Executive Offi cer
Tengion, Inc.
Director since 2007
Robert J. Palmisano
President & Chief Executive Offi cer
Wright Medical Group, Inc.
Director since 2011
Amy S. Paul 3
Former Group VP, International
C.R. Bard, Inc.
Director since 2008
Robert J. Quillinan 1*
Former Chief Financial Offi cer
Coherent, Inc.
Director since 2006
David D. Stevens 3
Former Chief Executive Offi cer
Accredo Health, Inc.
Director since 2004 &
Chairman of the Board
committees of the Board of Directors
1 – audit committee
2 – compensation committee
3 – nominating, compliance and
governance committee
* denotes chairman of the committee