ITEM 1. BUSINESS.
GENERAL
Biomet, Inc., an Indiana corporation incorporated in 1977 ("Biomet"), and its subsidiaries design, manufacture and market products used primarily by orthopedic medical specialists in both surgical and non-surgical therapy, including reconstructive and fixation devices, electrical bone growth stimulators, orthopedic support devices, operating room supplies, general surgical instruments, arthroscopy products, spinal implants and craniomaxillofacial products and instruments. Biomet has corporate headquarters in Warsaw, Indiana, and manufacturing and/or office facilities in more than twenty locations worldwide. Biomet markets its products in the United States through independent commissioned sales representatives, in the United Kingdom and Germany primarily through direct factory sales representatives, and in other international markets through both independent and direct factory sales representatives and specialty medical product dealers. Electro-Biology, Inc. ("EBI"), Biomet's principal domestic subsidiary, sells electrical stimulation and external fixation devices through direct factory sales representatives in the United States and the United Kingdom and through specialty medical product dealers in the remainder of its markets. Biomet and its subsidiaries currently distribute products in more than 100 countries.
Unless the context requires otherwise, the term "Company" as used herein refers to Biomet and all of its subsidiaries.
PRODUCTS
The Company's products can be divided into three groups: Reconstructive Products, EBI Products and Other Products. The Company's Reconstructive Products (principally hips, knees and shoulders) and certain of its Other Products (fixation devices, orthopedic support devices and operating room supplies) are designed, manufactured and/or marketed under the Biomet(R), Kirschner(R), and IQL(TM) trade names. Also included in Other Products are craniomaxillofacial products and instruments and general surgical instruments which are marketed under the Walter Lorenz(R) trade name, orthopedic support devices manufactured and marketed under the AOA(R) name, and arthroscopy products manufactured and marketed under the Arthrotek(R) name. Through EBI(R), the Company develops, manufactures and markets non-invasive and implantable electrical bone growth and spinal fusion stimulators and external fixation devices (the "EBI Products"). The following table shows the net sales and percentages of net sales contributed by each of these product groups for each of the three most recent fiscal years ended May 31, 1997.
RECONSTRUCTIVE PRODUCTS
Reconstructive Products are used to replace joints which have deteriorated as a result of disease (principally arthritis and osteoporosis) or injury. Reconstructive joint surgery involves the modification of the area surrounding the affected joint and the insertion of one or more manufactured components. The Company's primary reconstructive joints are the hip, knee and shoulder, but it also has the capability of producing other peripheral joints (including the ankle and elbow). The Company also produces the associated instruments required by the orthopedic surgeon to implant the Company's Reconstructive Products.
All femoral hip prostheses produced by the Company consist of a femoral head, neck and stem, which can be cast, forged or machined depending on the design and material used. Because of variations in human anatomy and differing design preferences among surgeons, femoral prostheses are manufactured by the Company in a variety of head sizes, neck lengths, stem lengths, stem cross-sections and configurations. The Company currently offers several total hip systems, most of which utilize titanium or cobalt chromium alloy femoral components and ultra-high molecular weight polyethylene-lined acetabular components. Many of the femoral prostheses utilize a porous coating which enhances the attachment of bone cement to the stem, or in a press-fit configuration, allows the component's use without bone cement.
Since February 1994, Biomet has received clearance under Section 510(k) of the Federal Food, Drug and Cosmetic Act for many of its porous-coated hip components for cementless use. These clearances are specifically for noncemented applications in skeletally mature patients undergoing primary hip replacement surgery as a result of noninflammatory degenerative joint diseases including osteoarthritis, avascular necrosis, traumatic arthritis, slipped capital epiphysis, fused hip, fracture of the pelvis and diastrophic variant.
Since 1985, one of Biomet's largest selling reconstructive systems has been the Mallory-Head(R) Total Hip System. The Mallory-Head Hip System is designed to meet surgeon's needs for both primary and revision total hip arthroplasty. The primary femoral components feature a specific proximal geometry for cementless indications and a slightly different proximal ribbed geometry for those patients requiring fixation with bone cement. The goal of each of these primary femoral stems is to ensure proximal loading of the femur to recreate near-normal bone stresses.
The Mallory-Head revision femoral components provide innovative solutions for difficult revision cases. The long stem revision components feature the primary proximal finned geometry with additional stem lengths to bridge cortical bone defects and to provide increased stability. The head/neck porous revision components feature multiple resection levels to compensate for proximal bone deficiencies. An optional trochanteric bolt or claw provides additional rotational stability and implant fixation. In May 1995, the FDA cleared the Mallory-Head Modular Calcar System for cemented use. This system provides the surgeon with intraoperative flexibility to independently size the proximal and distal femur with the appropriate implant size and shape, even in cases of severe bone deficiency. This is accomplished by using interchangeable modular subcomponents.
The Alliance(R) family is designed to address the growing trend toward standardization of total hip systems within hospitals and across surgeon groups. The Alliance family provides the largest selection of primary and revision stems available for implantation with a single set of instrumentation. The Alliance family includes the Integral(R), Bi-Metric(R), Answer(R), Hip Fracture(TM) and Rx90(R) Hip Systems.
The Maxim(R) Complete Knee System incorporates primary, posterior stabilized and revision components with state-of-the-art biomaterials and competes in the revision constrained knee market segment, addressing surgical situations where the surgeon is required to replace a knee that has compromised soft tissue and instability. The Company also has developed supporting instrumentation for the implantation of the Maxim Total Knee System components. The Maxim Total Knee System is the Company's largest selling knee system.
The Company's AGC(R) Total Knee System is one of the most clinically successful comprehensive total knee systems in the orthopedic industry. The AGC Total Knee System consists of cobalt chromium alloy femoral components, matching reinforced tibial components and appropriately sized reinforced patella components for patellar resurfacing. AGC components are available either with or without a porous titanium alloy surface designed to enhance the attachment of bone cement to the implant surfaces. The Company, in conjunction with developing surgeons, has also developed surgical techniques and supporting implantation instruments for the AGC and its other knee systems. These instruments allow for accurate implantation of the components and improved ligament and tendon balance in the knee following the surgical procedure. The Company has expanded its total knee product line to include the Finn(R) Knee Replacement System. This system offers both resurfacing and segmental component options in a wide range of sizes to address severe bone loss due to a previous failure or tumor resections. The Performance(R) Modular Total Knee System provides a full range of implant components designed to meet the wide variety of surgical indications seen in today's total knee patient population.
During fiscal year 1997, the Company received 510(k) clearance for the Bi-Polar Shoulder System. The Bi-Polar humeral head is marketed for use in primary cases of noninflammatory degenerative joint disease, rheumatoid arthritis, correction of severe functional deformity and fracture. The Bi-Polar Shoulder System was introduced to the United States market in February 1997. (See "Government Regulation" section for a general discussion of the regulatory clearance and approval process.)
The Integrated(TM) Shoulder System offers surgeons a wide variety of reconstructive products. As part of the Integrated Shoulder System, the Atlas(R) Modular shoulder prosthesis was introduced during fiscal year 1996 to further augment the surgeon's ability to match the prosthesis to the individual patient. This device incorporates a modular stem as well as a modular head to reduce the inventory required to support a shoulder procedure. Since its introduction in the late 1980s, the Bio-Modular Total Shoulder System has proven to be clinically effective and versatile. This system was designed to simplify the shoulder replacement procedure and surpass the durability and clinical outcome requirements of previous designs.
Biomet's Patient-Matched Implant ("PMI(R)") services group expeditiously designs, manufactures and delivers one-of-a-kind reconstructive and trauma devices to orthopedic specialists. The Company believes this service continues to enhance Biomet's reconstructive sales. In order to assist orthopedic surgeons and their surgical teams in preoperative planning, Biomet's PMI group utilizes a three-dimensional ("3-D") bone and soft tissue reconstruction imaging system. A patented technology owned by the Company allows the use of CT or MRI data to produce 3-D reconstructions for the design and manufacture of patient-matched implants. With this imaging technology, Biomet's PMI group is able to assist the physician, prior to surgery, by creating electronic 3-D models. Within strict deadlines, the model is translated into a PMI design for the actual manufacturing of the custom implant for the patient. Biomet continues to advance the application of imaging technology for the design and production of reconstructive devices for various joints of the body.
In July 1993, the Company received 510(k) clearance from the United States Food and Drug Administration ("FDA") for hip and knee polyethylene components manufactured according to a patented process and marketed under the trademark, ArCom.(R) ArCom components are machined from uniform compression molded bar stock manufactured by Biomet, or molded directly from high molecular weight polyethylene resin. The processes used to mold devices and manufacture bar stock are designed to maximize mechanical and wear properties of the polyethylene bearing material. In addition, the finished components are packaged in argon, an inert gas, to avoid oxidative degradation during and after sterilization.
The Company manufactures and distributes the patented Ultra-Drive(R) Revision System ("Ultra-Drive") which utilizes ultrasonic technology to safely and effectively remove bone cement and implants during revision arthroplasty procedures. This system reduces the amount of time the orthopedic surgeon would usually spend removing an implant and cement during revision procedures. Additionally, the Ultra-Drive reduces the possibility of accidental bone trauma associated with conventional methods addressing bone cement removal.
Reconstructive devices contributing to the Company's sales growth include the Maxim Total Knee System, the Bio-Modular(R) Shoulder System, the Mallory-Head Total Hip System, ArCom polyethylene products and the Alliance family of total hip implants.
EBI PRODUCTS
EBI's primary product categories consist of invasive and non-invasive electrical stimulation devices used in the treatment of recalcitrant bone fractures (nonunions), spinal fusion stimulation devices used as an adjunctive treatment in spinal fusion procedures, external fixation devices and a controlled cold therapy unit to aid in the reduction of postoperative pain, edema and blood loss. The FDA has defined a "nonunion" as a case in which nine months have elapsed from the date of a fracture with no sign of healing for three months. EBI's non-invasive devices generally provide an alternative to surgical intervention in the treatment of recalcitrant bone fractures and failed joint fusions.
One of EBI's primary products, the EBI Bone Healing System(R), is a non-invasive device which produces low-energy pulsed electromagnetic field ("PEMF") signals that induce weak pulsing currents in living tissues exposed to the signals. These pulses, when suitably configured in amplitude, repetition rate and duration, affect bone cells. EBI's non-invasive stimulator has two components: treatment heads and a control unit. The treatment heads contain electrical coils and are connected to the control unit. The control unit transforms household current or battery power into a predetermined sequence of pulsed currents that are induced into the fracture site through the treatment heads which may be placed over a patient's cast, incorporated into the cast, or worn over the skin.
EBI's Model 1200 Bone Healing System utilizes household current, or a rechargeable power supply, and allows for complete patient ambulation during treatment. This model usually incorporates the treatment coil into the patient's cast or the coil can be worn over the skin if required. The coil design is capable of treating the vast majority of nonunion fracture locations. The device can be pre-programmed as to duration of daily treatment and for patient compliance history. The Model 1200 Bone Healing System is a light-weight, smaller and easier to use unit, which was designed to encourage patient compliance and enhance clinical success. EBI intends to introduce a newly designed compact version of the Bone Healing System Model 2100 during fiscal year 1998.
EBI also manufactures the FLX(R) Flexible Treatment Coils for use with the EBI Bone Healing System. The FLX Flexible Treatment Coils are extremely lightweight and provide a slim profile that enhances patient comfort and compliance during bone healing treatment regimens. When used conjunctively with the EBI Bone Healing System, the FLX Flexible Treatment Coils afford higher bone healing success rates. Additionally, EBI offers a series of coils to address shoulder, foot, ankle, clavicle and metatarsal site applications and an elliptical coil to be used with external fixation.
The invasive electrical stimulation devices provide an adjunct to surgical intervention in the treatment of nonunions and spinal fusions. Spinal fusions are surgical procedures undertaken to establish bony union between adjacent vertebrae. EBI's SpF(R) Implantable Spinal Fusion Stimulators are used in conjunction with bone grafting to increase the probability of fusion success. EBI's SpF-2, a two lead implantable spinal fusion stimulator, allows EBI to offer orthopedic surgeons the SpF spinal fusion technology for the growing bilateral/lateral procedure market. Another SpF product, the SpF-T Implantable Spinal Fusion Stimulator, incorporates a telemetry device which emits a signal to allow device monitoring after implantation. The compact design of the SpF-T provides easier surgical implantation and explantation while increasing patient comfort. EBI's SpF-XL, is designed to address multilevel fusions of 3 to 5 levels. The XL has longer leads and delivers 40 mega amps of output. In fiscal year 1996, the XL line was expanded to include the SpF-XLII which provides the same benefits as the XL, in a two lead configuration. The implantable devices consist of a generator providing a constant direct current to a titanium cathode placed where bone growth is required. Over the years EBI has developed new techniques and device modifications for the SpF product line. These techniques and modifications address the anterior and posterior lumbar interbody fusion market segments.
During fiscal year 1996, EBI launched its own external fixation system, the EBI X FIX(TM) DynaFix(R) System. Market acceptance of the EBI X FIX DynaFix System has been extremely positive, and it is currently the leading external fixation system in the United States. During fiscal year 1998, EBI plans to introduce product extensions of the DynaFix System.
EBI began distribution of its line of controlled cold therapy units during fiscal year 1996. EBIce(TM), the first disposable and portable controlled cold therapy product offered by the Company, is used to aid in the reduction of postoperative pain, edema and blood loss. EBIce is receiving strong market acceptance in the estimated $25 million domestic cold therapy products market.
At the end of fiscal year 1997, EBI introduced for limited introduction in the United States, a new spinal hardware system called SpineLink,(TM) a universal spine system that addresses many of the inherent drawbacks of traditional rod and plate systems. With the SpineLink system, each spine segment is addressed individually for intrasegmental control. Through the use of a modular link and polydirectional screw, this unique system provides an intrasegmental solution to spine fixation, enabling the surgeon to tailor the segmental construction to the patient's anatomy.
EBI plans to introduce the SynthoCast(R) HP high performance casting tape during fiscal year 1998. This casting material is lighter, stronger and more comfortable than conventional plaster products. The SynthoCast tape offers pre-cut splints on a roll which saves time, controls waste and improves the convenience for the patient and physician.
OTHER PRODUCTS
The Company also manufactures and distributes several other products including fixation devices, orthopedic support devices, operating room supplies, arthroscopy products and craniomaxillofacial products. AOA, a division of EBI, manufactures and distributes its own extensive line of orthopedic support products. Arthrotek manufactures and markets a line of arthroscopy products. Walter Lorenz Surgical, Inc. ("Lorenz Surgical") manufactures and markets the craniomaxillofacial product line and the LactoSorb(R) Resorbable Craniomaxillofacial Fixation System.
The Indiana Tome(TM) Carpal Tunnel Release System is an innovation in carpal tunnel release. This patented system combines the best aspects of both the minimally invasive endoscopic approach and the traditional open procedure. Clinical investigation began on this system in November 1992 with full market release during fiscal year 1997.
FIXATION DEVICES. The Company's fixation devices include internal bone fixation devices such as nails, plates, screws, pins and wires designed to temporarily stabilize traumatic bone injuries. These devices are used by orthopedic surgeons to provide an accurate means of setting and stabilizing fractures. These implants are intended as aids to healing and may be removed when healing is completed; they are not intended to replace normal body structures.
The Uniflex(R) Nailing System, which is the Company's largest selling internal fixation system, addresses a wide range of fractures utilizing one product system. The Uniflex Femoral Nailing System is used for internal fixation of femoral fractures. The flexibility of the system enhances the load transfer to the bone to further aid in the healing of the fracture. The Uniflex Nailing System also includes tibial and humeral nailing systems. In addition, the S.S.T.(R) small bone locking nail and the Vector(R) Intertrochanteric Nail, a compression nailing system, enhance the Company's intramedullary fracture fixation family. The Biomet(R) Retrograde Femoral Nail is a clinical option for femoral fractures that occur below mid-shaft. The Retrograde Femoral Nail completes the Company's line of nailing systems by allowing for the treatment of distal femoral fractures.
The Compression Hip Screw System was designed to provide strong and stable internal fixation for a variety of intertrochanteric, subtrochanteric and basilar neck fractures. The BMP(TM) Cable System is used intraoperatively, often as part of revision hip surgery, to reduce the risk of fracture or to repair existing femoral fractures. System specific instrumentation for the BMP Cable System is precise and allows reproducible results.
ORTHOPEDIC SUPPORT DEVICES. The Company produces an extensive line of standard orthopedic support devices, many of which are sold under the CTN(R) and START(R) trademarks. These devices include elbow, wrist, abdominal, thigh and ankle supports, in addition to a wide variety of knee immobilizers and braces. The CTN product line primarily addresses the sports medicine market. CTN compression wraps with Soft-Ice(R) are used in compression cold-therapy treatment, both post-operative and during rehabilitation. The Company also distributes the Active Ankle(R), a unique ankle stirrup brace which addresses the sports rehabilitation market.
AOA's line of orthopedic support devices includes traction framing equipment, back supports, wrist and forearm splints, cervical collars, shoulder immobilizers, slings, abdominal binders, knee braces and immobilizers, rib belts, ankle supports and a variety of other orthopedic splints. In addition to these products, AOA manufactures and distributes a variety of casting products for use in the application and removal of orthopedic casts and splints. Included in these products are both synthetic casting tape and synthetic splints fabricated using an advanced fiberglass/polyester substrate material impregnated with a polymer resulting in casting and splinting products that are lightweight, high strength and available in a variety of colors.
OPERATING ROOM SUPPLIES. The Company's principal products in the operating room supplies category are surgical suction devices, filters, glove liners and drapes. The Redi-Vacette(R) Closed Wound Suction System provides post-operative wound suction drainage following orthopedic and nonorthopedic surgical procedures. The Redi-Flow(R) Filter automatically strains the flow of body liquids during surgery. The filter collects fine bone chips and tissue for subsequent pathological evaluation and saves operating room time by reducing suction clogs in surgical procedures. The Redi-Drape(R) protects the sterile operating field from contamination, and provides a drainage bag and built-in instrument pouches to assist the surgeon.
The Company's patented Blockaid(R) cut-resistant glove liner represents a breakthrough in continuous filament knitting technology, allowing stainless steel to be encased in synthetic fibers and providing the most cut-resistant fabric in the market today. Unlike thicker, spun fibers, these glove liners are thin enough to allow continued tactile sensitivity. This product reduces the risk of exposure of operating room personnel to infectious diseases.
ARTHROSCOPY PRODUCTS. Arthroscopy is a less-invasive orthopedic surgical procedure in which an arthroscope is inserted through a small incision to allow the surgeon direct visualization of the joint. This market is comprised of five product categories: power instruments, manual instruments, visualization products, soft tissue anchors and procedure-specific instruments and implants. Arthrotek's principal products consist of the Harpoon(R) Soft Tissue Anchor System, the IES(R) 1000 System, the PowerPump(R) 800, the Tunneloc(TM) ACL Fixation System and manual instruments featuring the Ellipticut(R) and BackBiter(R) instruments. The IES 1000 System is a fully-integrated arthroscopy system consisting of a camera, light source, shaver, pump, monitor, printer and VCR contained in a pre-wired cart. The PowerPump 800 provides the ability for surgeons to independently control flow and pressure and use the pump in conjunction with other arthroscopy shaver systems. The Tunneloc System was augmented with the Bone Mulch(TM) Screw, which received 510(k) clearance from the FDA during fiscal year 1995 and was released in fiscal year 1996. Also released during fiscal year 1996 was the One Step(TM) ACL Guide System, a patented design for use in anterior cruciate ligament reconstruction.
CRANIOMAXILLOFACIAL PRODUCTS. The Company manufactures and distributes craniomaxillofacial and neurosurgical titanium implants, along with associated surgical instrumentation, principally marketed to craniomaxillofacial, neurosurgical and craniofacial surgeons through its Lorenz Surgical subsidiary headquartered in Jacksonville, Florida. Craniomaxillofacial surgical instruments, exodontia instruments, Hard Tissue Replacement Polymer Facial Implants and custom craniofacial implants, as well as electric powered surgical drills and saws for use in craniomaxillofacial and small bone surgery are among the products offered by Lorenz Surgical. Lorenz Surgical manufactures and markets resorbable plate and screw systems for craniomaxillofacial surgery in the United States, the European community, the Pacific Rim, Canada, South America and South Africa.
The introduction of the LactoSorb System, the first resorbable craniomaxillofacial fixation system available on the market, has increased access into certain niche markets previously dominated by the competition. The LactoSorb Craniomaxillofacial Fixation System is a copolymer of poly-l-lactic acid and polyglycolic acid. The LactoSorb System is comparable in strength to titanium plating systems and is completely resorbed within nine to fifteen months after implantation. The initial market response for the LactoSorb System has been positive, especially in pediatric and craniofacial reconstruction cases.
Soft-Ice(R) is a registered trademark of Polar Products, Inc. Active Ankle(R) is a registered trademark of Active Ankle, Inc.
PRODUCT DEVELOPMENT
For the years ended May 31, 1997, 1996 and 1995, the Company expended approximately $23,201,000, $24,054,000 and $21,770,000, respectively, on research and development. It is expected that research and development expenses will increase. The Company's principal research and development efforts relate to its reconstructive devices, electrical stimulation products, spinal fixation products, fixation products, arthroscopy products and resorbable technology.
The Company's research and development efforts contributed to the introduction in fiscal year 1997 of the following products: Mallory Head Radial(TM) Acetabular Cup, Bi-Polar Shoulder, AGC HPS Knee, Tri-Spiked Acetabular Cup, and the introduction of the TRAC(TM) Knee System in Europe.
EBI conducts a program of research and development intended to maintain its proprietary position and to expand the range of conditions treatable with its electrical stimulation products. This program includes clinical investigations and funding of basic research to study cells and simple biological systems. Typically, EBI receives proprietary rights with respect to the data developed as the result of research it sponsors.
In July 1991, the Company and United States Surgical Corporation ("U.S. Surgical") entered into a cooperative effort to develop and market a line of state-of-the-art bioresorbable orthopedic and oral-maxillofacial implants. On March 15, 1996, that effort was terminated by a mutual agreement under the terms of which each of the parties retains the right to pursue the technologies developed during their joint efforts. The Company and U.S. Surgical have agreed not to sell products that incorporate the type of resorbable materials used during the cooperative effort in the orthopedic and oral-maxillofacial markets, respectively, until March 15, 1999.
GOVERNMENT REGULATION
The development, testing, marketing and manufacture of medical devices - such as arthroscopy, reconstructive and electrical stimulation products and internal fixation devices - are regulated under the Medical Device Amendments of 1976 to the Federal Food, Drug and Cosmetic Act (the "1976 Amendments") and additional regulations promulgated by the FDA. In general, these statutes and regulations require that manufacturers adhere to certain standards designed to ensure the safety and effectiveness of medical devices.
Under the 1976 Amendments, each medical device manufacturer must be a "registered device manufacturer" and must comply with regulations applicable generally to labeling, quality assurance, manufacturing practices and clinical investigations involving humans. The FDA is authorized to obtain and inspect devices, their labeling and advertising, and the facilities in which they are manufactured in order to assure that a device is not improperly manufactured or labeled. Biomet, EBI, Lorenz Surgical, Arthrotek, AOA and Biomet Ltd. are registered with the FDA.
In addition, the sale and marketing of specific medical devices are regulated by the FDA under the 1976 Amendments, which classify medical devices based upon the degree of regulation deemed appropriate and necessary. A device is classified as a Class I, II or III device based on recommendations of advisory panels appointed by the FDA. Class I devices are subject only to general controls. Class II devices, in addition to general controls, are subject to additional controls. Class III devices, including most devices used or implanted in the body, require FDA premarket approval before they may be distributed other than in clinical trials.
The Company's reconstructive and trauma products are regulated as Class II or Class III medical devices. The Company's electrical stimulation products are regulated as Class III medical devices. The procedure for obtaining approval to commercially market a device involves the submission of a premarket notification under Section 510(k) of the 1976 Amendments. If the FDA determines that the device is substantially equivalent to a pre-enactment device subsequently classified in Class I or Class II, it will grant clearance to commercially market the device. If the FDA determines the device is not substantially equivalent to a pre-enactment device, it is automatically placed into Class III, and will either require reclassification or the submission of valid scientific evidence to prove the device is safe and effective for human use. For Class III devices, in order to conduct clinical trials the manufacturer must submit to the FDA an application for an Investigational Device Exemption ("IDE"). An approved IDE exempts the manufacturer from certain otherwise applicable FDA regulations and grants approval for a clinical investigation, or human study, to generate clinical data to prove safety and efficacy. In addition, the possibility exists that certain devices marketed prior to 1976, or devices substantially equivalent thereto, may be placed into Class III by the FDA. In this event, the manufacturer will be required to submit proof of safety and efficacy for these devices within 30 months of the Class III determination.
When a manufacturer believes that sufficient clinical data has been generated to prove the safety and efficacy of the device, it may submit a premarket approval application ("PMA") to the FDA. The FDA reviews the PMA and determines whether it is in fileable form and all key elements have been included. Following acceptance of the PMA, the FDA continues its review process which includes submission of the PMA to a panel of experts appointed by the FDA to review the PMA and to recommend appropriate action. The panel then recommends that the PMA be approved, not approved or approved subject to conditions. The FDA may act according to the panel's recommendations, or it may overrule the panel. In approving a PMA, the FDA may
require some form of post-market surveillance whereby the manufacturer follows certain patient groups for two or more years, making periodic reports to the FDA.
The Safe Medical Device Act of 1990 (the "Act") affects medical device manufacturers in several areas, including post-market surveillance and device tracking procedures. The Act is the first major change to the Federal Food, Drug and Cosmetic Act since the 1976 Amendments. The Act gives the FDA expanded emergency recall authority, requires that a summary be made available of the safety and effectiveness in the 510(k) process and adds design validation as a requirement of Good Manufacturing Practices. The Act also grants the FDA the authority to require manufacturers to conduct post-market surveillance on most permanent implants and devices that potentially present a serious risk to human health. Management does not believe the Act has had a material adverse effect on the Company or its operations.
The Company is currently positioning itself for the changing international regulatory environment. "ISO 9000" is an internationally recognized set of guidelines that are aimed at ensuring the manufacture of quality products. A company that passes an ISO audit becomes internationally recognized as being well-run and functioning under a quality system. Thirty countries recognize ISO 9000 for medical products. ISO 9000 certified companies are able to sell their products in these countries without the added burden of individual country regulations. Although not required until 1998, the Company has taken the first steps in obtaining this registration. The Company's facilities located in Warsaw, IN, Parsippany, NJ, Fairlawn, NJ, Jacksonville, FL, and Guaynabo, Puerto Rico, U.S.A.; Bridgend, South Wales and Swindon, England, United Kingdom; Berlin, Germany; and Valencia, Spain have passed this audit and are registered. EBI has established itself in the international market through product registration. The Company's other facilities are preparing for their certification audits in fiscal year 1998.
SALES AND MARKETING
Biomet products are distributed in the United States through approximately 350 independent commissioned sales representatives ("distributors") and sales associates engaged principally in the business of supplying orthopedic products to hospitals in their geographic areas. Some of these distributors have formal contractual arrangements with Biomet which limit Biomet's right to terminate the distributor and provide certain long-term benefits to the distributor upon termination.
EBI's products and AOA's products are distributed in the United States through EBI's wholly-owned subsidiary, EBI Medical Systems, Inc. ("EBIMS"), a Delaware corporation with offices in Parsippany, New Jersey. EBIMS maintains a direct sales force of over 200 people which operates in assigned territories throughout the United States. Internationally, EBI and AOA products are distributed through a growing distribution network in Central and South America, Canada, Asia and Europe.
Lorenz Surgical products are distributed in the United States through approximately 75 independent commissioned sales representatives and sales associates engaged principally in the business of supplying craniomaxillofacial products and surgical instruments to hospitals and surgeons in their geographic areas. Additionally, Lorenz Surgical supplies a full-line of surgical hand-held instruments for sale through the Biomet distributor network. Lorenz Surgical products are marketed internationally through a growing network of distributors and factory sales representatives throughout Europe, Asia, Africa, Canada, and Central and South America.
Elective surgery-related products appear to be influenced to some degree by seasonal factors, as the number of elective procedures decline during the summer months and the holiday seasons.
The Company's customers are the hospitals, surgeons, other physicians and healthcare providers who employ its products in the course of their practices. The business of the Company is dependent upon the relationships maintained by its distributors and salespersons with these customers as well as the Company's ability to design and manufacture products which will meet the physicians' technical requirements at a competitive price.
The Company's products are marketed internationally primarily through direct factory sales representatives in the United Kingdom, Italy, France, Holland, Spain, Poland, Germany, Belgium, New Zealand, and Australia and through both independent and direct factory sales representatives and specialty medical product dealers in other international markets. The Company's products are distributed in approximately 100 countries worldwide.
For the fiscal years ended May 31, 1997, 1996 and 1995, the Company's foreign sales were approximately $154,825,000, $138,452,000, and $108,461,000, respectively, or 27%, 26%, and 24% of net sales, respectively. Additional data concerning operating income and identifiable assets by geographic areas are set forth in Note J of the Notes to Consolidated Financial Statements included in Item 8 of this Report.
The Company consigns inventory to its United States distributors and direct salespersons for their use in marketing its products and in filling customer orders. The Company also consigns inventory to hospitals in the United Kingdom, Italy, France, Holland, Spain, Poland, Germany, Belgium, New Zealand and Australia. As of May 31, 1997, inventory of approximately $49,027,000 was consigned to these distributors, salespersons and hospitals.
Under Title VI of the Social Security Amendments of 1983 (the "1983 Amendments"), hospitals receive a predetermined amount of Medicare reimbursement for treating a particular patient based upon the patient's type of illness identified with reference to the patient's diagnosis under one or more of several hundred diagnosis-related groups ("DRG"). Other factors which affect a specific hospital's reimbursement rate include the size of the hospital, its teaching status and its geographic location. The Prospective Payment Assessment Commission acts for Congress in evaluating, redefining and adjusting DRGs to encompass technology changes and efficiencies experienced by hospitals. Biomet products are primarily covered by DRG 209 (Major Joint and Limb Reattachment Procedures) and DRG 210 (Hip and Femur Procedures). The 1983 Amendments have not adversely affected the Company's reconstructive device or electrical stimulation business, however, the future impact of these amendments can not be estimated at the present time.
During fiscal year 1997, Biomet created the National Orthopaedic Alliance (NOA). NOA's mission is to provide management services and managed care related products, programs and services to orthopaedic surgeons for the purpose of assisting them in maintaining the value, control and independence of their medical practices. NOA is the result of merging the programs, services and staff of the Health Care Initiatives (HCI) and Biomet Professional Services departments. Under the direction of NOA, HCI will continue to provide an array of "value added" programs and services to assist Biomet's customers in addressing today's highly competitive health care environment. NOA plans to further enhance these programs and create new programs to increase the resources available to the Company's distributors and customers
COMPETITION
The business of the Company is highly competitive. Approximately seven other manufacturers offer orthopedic implant products which compete with Biomet products. Major companies in this industry include Zimmer, Inc., a subsidiary of Bristol-Myers Squibb Company; Howmedica, Inc., a subsidiary of Pfizer, Inc.; DePuy, Inc.; Smith & Nephew, Inc.; Osteonics, Inc., a subsidiary of Stryker Corporation; Johnson & Johnson Orthopaedics, Inc., a subsidiary of Johnson & Johnson; and Intermedics Orthopedics, Inc., a division of Sulzermedica. Management believes these seven companies, together with Biomet, have the predominant share of the orthopedic implant market. Competition within the orthopedic implant industry is primarily on the basis of service and product design, although price competition has become increasingly important in recent years as the orthopedic industry matures and as providers have become more concerned with health care costs. At the present time, price is a factor in the sale of generic internal fixation devices, orthopedic support devices and operating room supplies and is increasingly becoming a factor in the sale of reconstructive devices. In addition, health care providers increasingly limit the use of higher-cost reconstructive devices to younger, more active patients. Biomet's prices are at approximately the same or slightly lower levels as those of its major competitors. In recent years the Company has experienced pricing pressure for its products, however, the Company believes that the pricing environment is beginning to stabilize and we foresee an environment that will once again focus on quality of care. Biomet believes its future success will depend upon its service and responsiveness to distributors and orthopedic specialists, and upon its ability to design and market innovative products which meet the needs of the marketplace. As discussed above, NOA's programs are intended to enhance the Company's offerings of products and services.
EBI's electrical stimulation products compete with conventional surgical procedures and non-invasive electrical stimulation devices manufactured by others. EBI has the predominant share of the bone growth stimulation market. Other companies offering products in the electrical stimulation market include Orthofix, Inc., (formerly American Medical Electronics, Inc.) a subsidiary of Orthofix International N.V.; Biolectron, Inc.; OrthoLogic Corp. and Exogen, Inc. Competition in the electrical stimulation market is on the basis of product design, service and success rates of various treatment alternatives. EBI's non-invasive stimulators offer advantages over conventional surgery or invasive products in that their use eliminates hospital, surgeon and operating room costs, and these products can be used in the presence of infection without creating a risk of additional infection. EBI's invasive stimulators offer the advantage of conformance to surgical practice and do not require patient compliance. EBI's external fixation devices compete with other external fixation devices primarily on the basis of ease of application and clinical results. EBI's principal competitor in the external fixation market is Orthofix, Inc., see "Item 3. - Legal Proceedings."
Arthrotek products compete in the areas of power instruments, visualization products, accessories and manual instruments. Competitors include Linvatec Corp., a subsidiary of Bristol-Myers Squibb Company; Stryker Corporation; Smith and Nephew Endoscopy, a division of Smith & Nephew Ltd.; Arthrex, Inc.; Olympus; Richard Wolf and Karl Storz.
The Company's fixation product lines compete with those of ACE Orthopedics, a division of DePuy, Inc.; Zimmer, Inc., a subsidiary of Bristol-Myers Squibb Company; Richards Manufacturing Co., Inc., a subsidiary of Smith & Nephew Ltd. and Synthes USA.
Lorenz Surgical primarily competes in the surgical instrumentation and craniomaxillofacial markets. Its competitors include Synthes USA; Howmedica-Leibinger, a subsidiary of Pfizer, Inc.; ACE Surgical Supply Company, Inc. KLS-Martin, L.P. and Hu-Friedy Dental.
RAW MATERIALS AND SUPPLIES
The raw materials used in the manufacture of Biomet products are principally nonferrous metallic alloys, stainless steel, polyethylene powder and fabrics. With the exception of cobalt alloy and polyethylene powder, none of Biomet's raw material requirements are limited to any material extent by critical supply or single origins. Biomet purchases its cobalt alloy from two outside suppliers and is aware of at least three additional suppliers of cobalt alloy. With respect to polyethylene powder, suppliers of this material have become increasingly concerned because of perceived product liability exposures in the medical device industry. However, based upon Biomet's present relationship with such suppliers, a material shortage of polyethylene powder is not anticipated in the foreseeable future. EBI purchases all components of its electrical stimulators from approximately 250 outside suppliers, approximately 15 of whom are the single source of supply for their particular product. In most cases, EBI believes that all components are replaceable with similar components. In the event of a shortage, there are alternative sources of supply available for all components, but some time would likely elapse before EBI's orders could be filled. The results of the Company's operations are not materially dependent on raw material costs.
EMPLOYEES
As of May 31, 1997, the Company's domestic operations (including Puerto Rico) employed approximately 1,800 persons, of whom approximately 1050 were engaged in production and approximately 750 in sales, marketing, administrative and clerical efforts. The Company's international subsidiaries employed approximately 750 persons, of whom approximately 420 were engaged in production and approximately 330 in sales, marketing, administrative and clerical efforts. None of the Company's principal domestic manufacturing employees are represented by a labor union. The production employees at its Bridgend, South Wales, facility are organized. Employees working at the Berlin, Germany facility are represented by a statutory Workers' Council which negotiates labor hours and termination rights. The Workers' Council does not represent such employees with regard to collective bargaining of wages or benefits. The Company believes that its relationship with all of its employees is satisfactory. The establishment of Biomet's domestic operations in north central Indiana, near other members of the orthopedic industry, provides excellent access to the highly skilled machine operators required for the manufacture of Biomet products. The Company's European manufacturing locations in South Wales, England, Spain, and Germany, also provide good sources for skilled manufacturing labor. EBI's Puerto Rican operations principally involve the assembly of purchased components into finished products using skilled labor.
PATENTS AND TRADEMARKS
As a result of the rapid development of reconstructive products, patents historically have not been a major factor in the orthopedic industry. However, as the industry matures, patents and other forms of intellectual property are taking on an increased importance. Accordingly, management has placed greater significance on patents and is taking steps to increase its acquisition of intellectual property rights. In addition, management is actively enforcing its intellectual property rights consistent with strategic objectives.
Biomet, EBI, W. Lorenz, KIRSCHNER, AOA, IQL and Arthrotek are the Company's principal registered trademarks in the United States, and federal registration has been obtained or is in process with respect to various other trademarks associated with the Company's products. The Company holds or has applied for registrations of various trademarks in its principal foreign markets.
ITEM 2.
ITEM 2. PROPERTIES.
The Company has the following properties:
The Company believes that its facilities are adequate, well maintained and suitable for the development, manufacture and marketing of all its products.
*The operations at this facility have ceased and the facility is being leased to another party.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The Company recently has been and is now a party to several actions in which patent infringement is one of the claims made against it. The Company has also experienced a gradual increase in the number of product liability claims made against it. This increase would appear to reflect both the increasingly litigious nature of society and the significant increase in the number of patients who have received the Company's implants over the past 20 years.
On June 2, 1997, the Company announced the entry of a jury verdict against it in the United States District Court of New Jersey in an action brought by Orthofix SRL ("Orthofix") against the Company and its wholly owned subsidiaries, Electro-Biology, Inc. ("EBI") and EBI Medical Systems, Inc. ("EBIMS") (collectively the "Biomet Group"), related to the events surrounding the expiration of a distribution agreement under which EBIMS distributed Orthofix's external fixation devices in the United States. The jury found that, notwithstanding Orthofix's refusal to renew the distribution agreement, EBIMS's commencement of development activities on a new external fixation system prior to the expiration of the contract constituted a breach of the distribution agreement. The jury awarded damages against the Biomet Group for a breach of contract and related claims of approximately $49 million and punitive damages of $100 million. The jury also concluded that Orthofix breached the distribution agreement and tortiously interfered with EBIMS's economic relations, but awarded only nominal damages to the Biomet Group. With respect to certain nonjury issues, the trial court judge entered an order on July 23, 1997, denying Orthofix's motions for enhanced and/or treble damages and attorney's fees. The trial judge granted Orthofix's motion for prejudgment interest, but only on the compensatory portion of the damages commencing from November 29, 1995. The trial judge denied Orthofix's request for an injunction prohibiting EBIMS's sale or distribution of its remaining Orthofix inventory, although a final injunction was entered that prescribes the manner in which EBIMS can sell and distribute the inventory. The trial judge recently entered judgment in the amount of the jury's verdict and the Biomet Group has moved for a judgment notwithstanding the verdict, or a new trial. The Company intends to appeal any adverse final judgment entered against the Biomet Group.
In January of 1996, a jury returned a verdict in favor of Raymond G. Tronzo awarding him approximately $55 million on his patent and state law claims. On October 29,1996, the United Stated District Court for the Southern District of Florida entered a judgment, which implemented and reduced the jury verdict, awarding $30,207,435 to Tronzo on his state law claims, including compensatory damages of approximately $7.1 million, punitive damages of $20 million, and prejudgment interest. The trial court dismissed, with prejudice, Tronzo's claim based upon unjust enrichment. The trial court denied the Company's motion challenging the validity of Tronzo's patent. Tronzo was awarded an additional $6.3 million judgment for patent infringement, including a fifty percent enhancement based upon willfulness. The trial court also granted an injunction prohibiting future manufacture, use, promotion or sale, in the United States, of the finned version of the Mallory-Head acetabular cup, the device found to have infringed the Tronzo patent. The U.S. Court of Appeals for the Federal Circuit (the "Federal Circuit") has denied the Company's motion to stay the injunction pending the conclusion of the appeal. The Mallory/Head finned acetabular cup accounts for a relatively small portion of the Company's annual sales. The Company is vigorously pursuing its appeal before the Federal Circuit. It is anticipated that the court will issue its final decision on the appeal sometime in late 1997 or early 1998. In connection with the District Court's final judgment and its order granting a stay of enforcement and execution of the judgment, the Company was required to deliver to an escrow agent investments with a value no less than $36.6 million to be held in escrow, invested and disbursed for the benefit of the plaintiff pending the outcomes of all appeals.
Based on the information currently available and advice from legal counsel, management believes that the trial courts' judgments in the Tronzo and Orthofix cases will not be upheld upon appeal. Therefore, no amounts related to these two cases have been recorded in the Company's financial statements, except for estimated legal costs associated with the appeal process. If the Company is unsuccessful in its appeal of either, or both, of these cases, the ultimate liabilities could be material to the operating results in the period such losses are recognized. The Company's cash, cash equivalents and investments are adequate to address the payment of any losses that could ultimately be determined with respect to these two cases.
The Company and DePuy, Inc. were involved in litigation in which each each company made claims of patent infringement, and related claims, against the other with respect to several products. DePuy filed a lawsuit against Biomet and one of its employees alleging, among other things, that the Company makes and sells certain products which fall within the scope of DePuy's patents. The Company filed four patent infringement lawsuits against DePuy alleging, among other things, that certain DePuy products and surgical instrumentation infringed claims of the Company's patents. On February 25, 1997, DePuy and the Company agreed to settle all pending litigation and reported this agreement to the United States District Court for the Northern District of Indiana. All five cases were dismissed under a royalty-free cross-licensing arrangement between DePuy and the Company under which each party can continue to manufacture and distribute its respective current products. Under the terms of the settlement, no money exchanged hands and each party is responsible for its own costs and expenses.
Joint Medical Products Corporation ("Joint Medical") brought suit on January 28, 1997, in the U.S. District Court of Connecticut against Biomet, Inc., Kirschner Medical Corporation and several other manufacturers of orthopedic devices. The suit seeks injunctive relief and treble damages for the Company's alleged infringement of a patent owned by Joint Medical generally relating to certain acetabular cups which have an asymmetric bearing. Joint Medical has not served the complaint on
the Company and has offered the Company a license to this patent as well as any patent resulting from a reissue preceding involving the patent-in-suit that is currently pending in the United States Patent and Trademark Office. As to the lawsuit filed by Joint Medical, the Company's outside counsel has rendered an opinion that the claims of the patent are either invalid or not infringed. When required, the Company will vigorously defend the action filed against it.
The Company also has been and is now involved in disputes with certain of its independent commissioned sales representatives over various issues presented by the agreements between those sales representatives and the Company, including the right of the sales representative to distribute certain of the products of the Company and the right of the Company to terminate those relationships. Generally, these disputes relate to a small minority of the Company's sales representative relationships. Management does not anticipate that the resolution of these matters will have a material effect on the Company's financial position or future operations.
There are various other claims, lawsuits, disputes with third parties, investigations and pending actions involving various allegations against the Company incident to the operations of its business. The results of litigations proceedings cannot be predicted with certainty; however, management believes the ultimate disposition of these matters will not have a material adverse effect on the consolidated financial position of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not Applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
The name, age, business background, positions held with the Company and tenure as an executive officer of each of the Company's executive officers are set forth below. No family relationship exists among any of the executive officers. Except as otherwise stated, each executive officer has held the position indicated during the last five years.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The following table shows the quarterly range of high and low sales prices for the Company's Common Shares as reported by the Nasdaq Stock Market for each of the three most recent fiscal years ended May 31, 1997. The approximate number of recordholders of outstanding Common Shares as of May 31, 1997 was 10,200.
The Company paid a cash dividend of ten cents ($0.10) per share on November 22, 1996 to shareholders of record at the close of business on October 25, 1996. On July 2, 1997 the Company announced the declaration of a cash dividend of eleven cents ($.11) per share, payable August 8, 1997, to shareholders of record at the close of business on July 11, 1997.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
INCOME STATEMENT DATA
Years ended May 31, (in thousands, except earnings per share)
BALANCE SHEET DATA
As of May 31, (in thousands)
- - The selected consolidated financial information includes the operations of Kirschner Medical Corporation from November 4, 1994.
- - The Company paid a cash dividend of $.10 per common share in 1997. The Company paid no cash dividends during any of the other periods presented.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following table shows the percentage relationship to net sales of items derived from the Consolidated Statements of Income and the percentage change from year to year.
1997 COMPARED TO 1996
The Company experienced strong increases in operating income and net income in 1997, driven by growth in net sales and improvements in manufacturing productivity. Net income increased despite inclusion in 1996 of several nonrecurring items, which increased 1996 net income by approximately $2.1 million.
Net Sales - Net sales increased 8% from $535,159,000 in fiscal 1996 to $580,347,000 in fiscal 1997. The Company's U.S.-based revenues increased 7% to $425,522,000 in fiscal 1997, while foreign sales increased 12% in fiscal 1997 to $154,825,000. The Company continued to gain market share in the international and domestic reconstructive device markets as evidenced by an 8% increase in worldwide reconstructive device sales during 1997 to $352,122,000. Products contributing to this growth are the Maxim(R) Total Knee and Alliance(R) Hip Systems. In fiscal 1997, EBI's sales increased 5% to $114,321,000 due to strong sales of the SpF Spinal Fusion Stimulation System and the EBIce(TM) Controlled Cold Therapy System. Sales of EBI's DynaFix(TM) External Fixation System increased slightly from last year. The DynaFix System is becoming more widely accepted as the market-leading external fixation system in the United States. The Company's "Other Products" sales increased 14% in fiscal 1997 to $113,904,000, primarily as a result of increased sales of IQL's spinal products internationally and Biomet's fixation products and Lorenz's craniomaxillofacial products both in the domestic and international markets. In addition, Lorenz has strongly positioned itself in the domestic and international marketplace through an expanded distribution network.
Gross Profit - The Company's gross profit increased 9% from $360,795,000 in fiscal 1996 to $394,552,000 in fiscal 1997 primarily as a result of increased sales of higher margin reconstructive products, increased in-house manufacturing efficiencies of the external fixation product line, and improved margins realized through acquisitions of international distributors. As a percentage of net sales, gross profit was 68% in 1997 and 67.4% in 1996. Cost of sales increased from $174,364,000 in fiscal 1996 to $185,795,000 in fiscal 1997, due primarily to increased sales.
Selling, General and Administrative Expenses - Selling, general and administrative expenses increased slightly to $211,540,000 in fiscal 1997 from $199,461,000 in fiscal 1996. Increased litigation costs is the primary reason for this increase. Excluding litigation costs, selling, general and administrative expenses remained relatively level during the current year in comparison with fiscal 1996 as the Company continues to control costs through consolidation of key operations and other measures designed to improve operating efficiencies.
Research and Development Expense - Research and development expense in fiscal 1997 decreased to $23,201,000 from $24,054,000 in fiscal 1996. As a percentage of sales, research and development expense decreased from 4.5% in fiscal 1996 to 4.0% in fiscal 1997. The decrease in research and development expense is the result of the completion of the resorbable craniomaxillofacial products project and the termination of the United States Surgical Corporation ("USSC") joint venture. The Company will continue to invest in both its research and development staff and research and development activities.
Other Income - Other income decreased from $12,389,000 in 1996 to $9,321,000. This decrease was due to two nonrecurring items in fiscal 1996. First, the Company sold all of its holdings in American Medical Electronics, Inc. realizing a gain of $2.5 million and secondly, $2.9 million was received pursuant to the termination of a joint venture agreement with USSC. Excluding these nonrecurring items, the Company experienced an increase in other income in fiscal 1997 as a result of improved returns on its cash and investments.
Provision for Income Taxes - Provision for income taxes increased to $62,678,000 in fiscal 1997 compared to $55,563,000 in fiscal 1996, primarily as a result of increased income before taxes. The Company's effective tax rate remained at 37.1% in fiscal 1997. The Company will continue to be adversely affected by the changes in the Puerto Rico local tax structure and reduction of U.S. tax benefits from operating in Puerto Rico; however, the effect is not expected to be material to the consolidated tax provision.
Net Income - The factors mentioned above resulted in a 13% and 15% increase in net income and earnings per share, respectively, for fiscal 1997 as compared to fiscal 1996, increasing from $94,106,000 to $106,454,000 and $.82 to $.94, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company's net cash from operating activities totalled $122,998,000 in 1997 compared to $68,485,000 in 1996. This increase is largely due to increased net income, measures initiated in monitoring inventory levels and improvements in collections of accounts receivable balances. Although net sales increased 8%, accounts receivables increased only 5% and inventories remained level compared to last year. Included in the aforementioned changes were decreases in accounts and notes receivable and inventories attributable to the decrease from May 31, 1996 to May 31, 1997 in the exchange rates used to convert the financial statements of Biomet's foreign subsidiaries from their functional currency to the U.S. dollar. These decreases were immaterial and did not affect the Company's earnings during the year because foreign currency translation adjustments to balance sheet items are recognized as a component of shareholders' equity in the Company's consolidated balance sheet. The Company will continue to be exposed to the effects of foreign currency translation adjustments.
Cash flows used in investing activities were $56,151,000 in fiscal 1997 compared to cash flows provided by investing activities of $13,361,000 in fiscal 1996. The primary use of cash flows for investing activities was purchases of investments, purchases of capital equipment and the acquisition of two foreign distributors. Included in capital expenditures are costs to complete Lorenz's new manufacturing facility in Jacksonville, Florida and Biomet Deutschland's facility in Berlin, Germany. During the current fiscal year, Lorenz completed a 60,000 square foot expansion of its facilities which allowed consolidation of its manufacturing, research and development, marketing and distribution functions under one roof.
Cash flows used in financing activities were $87,898,000 in 1997 compared to $6,621,000 in 1996. The primary use of cash flows for financing activities were the purchase of the Company's Common Shares as part of the Common Share Repurchase Program and the Company's first cash dividend of ten cents ($.10) per share. On July 2, 1997, the Board of Directors declared a cash dividend of eleven cents ($.11) per share, payable August 8,1997 to shareholders of record at the close of business on July 11, 1997.
The Company expects to have significant capital requirements in the coming years and intends to continue to devote a substantial amount of time and resources to research and development. The Company expects to spend approximately $90 million during the next two fiscal years for capital expenditures and research and development, and expects additional outlays to fund future acquisitions and other business development activities. Management expects the funding for these aforementioned activities will come from currently available funds and cash flows generated from future operations.
LITIGATION AND OTHER MATTERS
As more fully described in Note K of the Notes to Consolidated Financial Statements, the Company is currently appealing adverse jury awards in two separate cases (Tronzo and Orthofix). The judgment in the Tronzo case, which involved patent infringement and state law claims, approximates $36.6 million and the judgment in the Orthofix case, which alleged breach of a distribution agreement, approximates $149 million, including punitive damages of $100 million. Management believes, based on available information and advice from legal counsel, that the judgments in both these cases will be reversed on appeal. Except for estimated litigation costs associated with the appeals process, no additional amounts have been accrued in the Company's consolidated financial statements. The Company's cash, cash equivalents and investments are adequate to address the payment of any losses that could ultimately result if the Company is unsuccessful in the appeal of these cases. As disclosed in Note K, the Company's investments include $36.6 million of investment securities which have been placed with an escrow agent pending the outcome of the appeal of the Tronzo judgment.
On May 19, 1997, Biomet and Merck KGaA, Darmstadt, Germany, announced their intention to enter into a joint venture to which Biomet and Merck KGaA each would contribute its existing European orthopedic operations. The joint venture with Merck KGaA, which is subject to the negotiation of a definitive agreement, certain regulatory approvals and approval by the Boards of Directors of both companies, would operate as "Biomet-Merck" and ownership would be shared 50/50. Merck KGaA
would bring to this venture an extensive array of chemical, biological, pharmaceutical and orthopedic technologies and products. Pro forma sales of the joint venture are estimated to approach $200 million. At this point in our discussions, the joint venture appears to provide an excellent strategic fit between Biomet's European operations and Merck KGaA's biomaterials division in terms of product lines, geographic distribution and core competencies.
In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128, " Earnings per Share." SFAS No. 128 requires all entities with complex capital structures to make a dual presentation of basic and diluted earnings per share on the face of the income statement and is effective for all financial statements issued for periods ending after December 15, 1997. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" both of which the Company will be required to adopt in its financial statements for the year ending May 31, 1999. SFAS No. 130 will require the Company to report comprehensive income in its financial statements. Comprehensive income includes net income and certain transactions that are reported as a separate component of shareholders' equity, such as translation adjustments and net unrealized appreciation of available-for-sale securities. SFAS No. 131 specifies revised guidelines for determining operating segments and the type and level of information to be disclosed. The Company has not yet determined what changes in its disclosures, if any, will be required by SFAS No. 131.
1996 COMPARED TO 1995
Net Sales - Net sales increased 18% to $535,159,000 in fiscal 1996 as compared to $452,272,000 in fiscal 1995. The Company's U.S.-based revenues increased 15% to $396,707,000 in fiscal 1996, while foreign sales increased 28% to $138,452,000. Worldwide reconstructive device sales during fiscal 1996 increased 20% to $326,834,000 compared to fiscal 1995. Products recording significant increases in unit sales include the Maxim(R) Total Knee System, the Bio-Modular(R) Shoulder and the Alliance(R) Hip System. In fiscal 1996, EBI's sales increased 10% to $108,627,000, principally as a result of increased sales of the DynaFix(TM) External Fixation System and the EBI Bone Healing System(R) Model 1200. The Company's "Other Products" revenues totaled $99,698,000, representing a 23% increase over fiscal 1995, primarily as a result of increased sales of Lorenz's craniomaxillofacial products, Biomet's fixation products, and the inclusion of a full year of Kirschner's AOA products.
Gross Profit - The Company's gross profit increased 16% to $360,795,000 in fiscal 1996 compared to $310,129,000 in fiscal 1995. Cost of sales increased as a percentage of sales to 32.6% for fiscal 1996 compared to 31.4% for fiscal 1995. This increase is due to the acquisition in November 1994 of Kirschner, whose cost of sales was historically higher than Biomet's due to its higher levels of outsourced product manufacturing.
Selling, General and Administrative Expenses - Selling, general and administrative expenses decreased to 37.2% of net sales in fiscal 1996 compared to 37.5% of net sales in fiscal 1995, primarily due to the reduction of payroll costs resulting from the consolidation of the Kirschner operation into the Warsaw operations, partially offset by $1.6 million paid in connection with the judgment in the Ramos litigation and legal expenses incurred in connection with the Tronzo litigation.
Research and Development Expense - Research and development expense increased by $2,284,000 during the current fiscal year reflecting the Company's commitment to remain competitive through technological advancements, but decreased as a percentage of net sales principally as a result of Kirschner's lower expenditures on research and development.
Other Income - The increase in other income is the result of income earned on higher investment balances throughout the year, a $2.5 million gain on marketable securities and $2.9 million received on the termination of a joint venture agreement with USSC, offset by $400,000 of interest expense related to the Ramos litigation.
Provision For Income Taxes - The effective income tax rate increased to 37.1% in fiscal 1996 compared to 36.6% in fiscal 1995. This increase is due to the changes in the Puerto Rico local tax structure and reduction of U.S. tax benefits from operating in Puerto Rico.
Net Income - These factors resulted in a 19% increase in net income and earnings per share for fiscal 1996 as compared to fiscal 1995, increasing from $79,200,000 to $94,106,000 and $.69 to $.82, respectively.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this Item is set forth on pages 23 through 36 of this Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information included under the caption "Election of Directors" in the Company's definitive Proxy Statement filed pursuant to Regulation 14A in connection with its 1997 Annual Meeting of Shareholders (the "Proxy Statement") is incorporated herein by reference in response to this item.
Information regarding executive officers of the Company is included in Part I of this Report under the caption "Executive Officers of the Registrant."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information included under the captions "Election of Directors - Compensation of Directors" and "Executive Compensation" in the Proxy Statement is incorporated herein by reference in response to this item.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information contained under the captions "Principal Shareholders" and "Share Ownership of Directors and Executive Officers" in the Proxy Statement is incorporated herein by reference in response to this item.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information contained under the caption "Certain Transactions" in the Proxy Statement is incorporated herein by reference in response to this item.
PART IV (ITEM 14.