10-Q 1 wmgi331201410q.htm 10-Q WMGI 3.31.2014 10Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
T
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2014
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number: 001-35823
WRIGHT MEDICAL GROUP, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
 
13-4088127
(State or Other Jurisdiction
 
(IRS Employer
of Incorporation or Organization)
 
Identification Number)
 
 
 
1023 Cherry Road
 
 
Memphis, Tennessee
 
38117
(Address of Principal Executive Offices)
 
(Zip Code)

(901) 867-9971
(Registrant’s Telephone Number, Including Area Code)
5677 Airline Road
Arlington, TN 38002
(Former Name, Former Address and Former Fiscal Year, if changed)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes T     No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes T     No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer T
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
 
 
(Do not check if a smaller reporting company)
 




Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes T No

As of April 23, 2014, there were 49,904,712 shares of common stock outstanding.
 



WRIGHT MEDICAL GROUP, INC.

TABLE OF CONTENTS

 
Page Number
 
 
 
 
 
 
 
 
 
 
 EX-10.27
 EX-31.1
 EX-31.2
 EX-32
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT



SAFE-HARBOR STATEMENT
Table of Contents
This Quarterly Report may contain “forward-looking statements” as defined under U.S. federal securities laws. These statements reflect management's current knowledge, assumptions, beliefs, estimates, and expectations and express management's current view of future performance, results, and trends. Forward looking statements 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 actual results to materially differ from those described in the forward-looking statements. The reader should not place undue reliance on forward-looking statements. Such statements are made as of the date of this Quarterly Report, 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 are discussed in our filings with the Securities and Exchange Commission (including in our Annual Report on Form 10-K for the year ended December 31, 2013 and in our Quarterly Reports on Form 10-Q, including this Quarterly Report for the quarter ended March 31, 2014, in each case under the heading “Risk Factors” and elsewhere in such filings). By way of example and without implied limitation, such risks and uncertainties include:

future actions of the SEC, the United States Attorney's office, the FDA, the Department of Health and Human Services or other U.S. or foreign government authorities, including those resulting from increased scrutiny under the Foreign Corrupt Practices Act and similar laws, that could delay, limit or suspend our development, manufacturing, commercialization and sale of products, or result in seizures, injunctions, monetary sanctions or criminal or civil liabilities;
continued liability for product liability claims on OrthoRecon products sold prior to divestiture of our OrthoRecon business or for post-market regulatory obligations on such products;
disruptions resulting from loss of personnel, systems and infrastructure changes and transition services arrangements in connection with our OrthoRecon divestiture;
failure to realize the anticipated benefits from our acquisitions or from divestiture of our OrthoRecon business;
adverse outcomes in existing product liability litigation;
new product liability claims;
inadequate insurance coverage;
copycat claims against our modular hip systems resulting from a competitor's recall of its modular hip product;
failure or delay in obtaining FDA approval of Augment® Bone Graft for commercial sale in the United States;
challenges to our intellectual property rights or inability to defend our products against the intellectual property rights of others;
loss of key suppliers;
failures of, interruptions to, or unauthorized tampering with our information technology systems;
failure or delay in obtaining FDA or other regulatory approvals for our products;
any actual or alleged breach of the Corporate Integrity Agreement to which we are subject through September 2015, which could expose us to significant liability, including exclusion from Medicare, Medicaid and other federal healthcare programs, potential criminal prosecution, and civil and criminal fines or penalties;
the potentially negative effect of our ongoing compliance enhancements on our relationships with customers and on our ability to deliver timely and effective medical education, clinical studies, and new products;
the possibility of private securities litigation or shareholder derivative suits;
insufficient demand for and market acceptance of our new and existing products;
recently enacted healthcare laws and changes in product reimbursements, which could generate downward pressure on our product pricing;
potentially burdensome tax measures;
lack of suitable business development opportunities;
inability to capitalize on business development opportunities;
product quality or patient safety issues;
geographic and product mix impact on our sales;
inability to retain key sales representatives, independent distributors and other personnel or to attract new talent;
inventory reductions or fluctuations in buying patterns by wholesalers or distributors; and
the negative impact of the commercial and credit environment on us, our customers and our suppliers.





PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (unaudited).

WRIGHT MEDICAL GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(unaudited)

 
March 31,
2014
 
December 31,
2013
Assets:
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
343,852

 
$
168,534

Marketable securities
9,247

 
6,898

Accounts receivable, net
50,778

 
45,817

Inventories
78,833

 
72,443

Prepaid expenses
8,294

 
6,508

Deferred income taxes
3,599

 
10,749

Other current assets
47,299

 
52,351

Current assets held for sale

 
142,015

Total current assets
541,902

 
505,315

Property, plant and equipment, net
75,601

 
70,515

Goodwill
201,625

 
118,263

Intangible assets, net
72,378

 
39,420

Marketable securities
3,499

 
7,650

Deferred income taxes
593

 
1,632

Other assets
128,251

 
132,213

Other assets held for sale

 
132,443

Total assets
$
1,023,849

 
$
1,007,451

Liabilities and Stockholders’ Equity:
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
11,030

 
$
3,913

Accrued expenses and other current liabilities
95,041

 
80,117

Current portion of long-term obligations
4,382

 
4,174

Current liabilities held for sale

 
31,221

Total current liabilities
110,453

 
119,425

Long-term debt and capital lease obligations
273,271

 
271,227

Deferred income taxes
15,482

 
20,620

Other liabilities
134,723

 
135,066

Other liabilities held for sale

 
1,399

Total liabilities
533,929

 
547,737

Commitments and contingencies (Note 12)

 

Stockholders’ equity:
 
 
 
Common stock, $.01 par value, authorized: 100,000,000 shares; issued and outstanding: 49,888,296 shares at March 31, 2014 and 47,993,765 shares at December 31, 2013
488

 
473

Additional paid-in capital
715,525

 
656,770

Accumulated other comprehensive income
19,809

 
17,953

Retained earnings
(245,902
)
 
(215,482
)
Total stockholders’ equity
489,920

 
459,714

Total liabilities and stockholders’ equity
$
1,023,849

 
$
1,007,451


The accompanying notes are an integral part of these condensed consolidated financial statements.

1


WRIGHT MEDICAL GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(unaudited)

 
Three Months Ended
 
March 31,
 
2014
 
2013
Net sales
$
71,062

 
$
56,293

Cost of sales 1
17,417

 
13,697

Gross profit
53,645

 
42,596

Operating expenses:
 
 
 
Selling, general and administrative 1
68,648

 
50,709

Research and development 1
5,856

 
3,507

Amortization of intangible assets
2,187

 
1,606

Total operating expenses
76,691

 
55,822

Operating loss
(23,046
)
 
(13,226
)
Interest expense, net
4,136

 
3,945

Other expense (income), net
15,286

 
(5,849
)
Net loss from continuing operations before income taxes
(42,468
)
 
(11,322
)
Benefit for income taxes
(12,170
)
 
(6,404
)
Net loss from continuing operations
$
(30,298
)
 
$
(4,918
)
(Loss) income from discontinued operations, net tax 1
(122
)
 
13,353

Net (loss) income
$
(30,420
)
 
$
8,435

Net loss from continuing operations per share (Note11):
 
 
 
Basic
$
(0.62
)
 
$
(0.12
)
Diluted
$
(0.62
)
 
$
(0.12
)
Net (loss) income per share (Note11):
 
 
 
Basic
$
(0.63
)
 
$
0.20

Diluted
$
(0.63
)
 
$
0.20

 
 
 
 
Weighted-average number of shares outstanding-basic
48,625

 
41,438

Weighted-average number of shares outstanding-diluted
48,625

 
42,139


___________________________
1 
These line items include the following amounts of non-cash, stock-based compensation expense for the periods indicated:

 
Three Months Ended
 
March 31,
 
2014
 
2013
Cost of sales
$
111

 
$
147

Selling, general and administrative
2,004

 
3,645

Research and development
205

 
121

Discontinued operations

 
705


The accompanying notes are an integral part of these condensed consolidated financial statements.

2


WRIGHT MEDICAL GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands, except per share data)
(unaudited)

 
Three Months Ended
 
March 31,
 
2014
 
2013
Net (loss) income
$
(30,420
)
 
$
8,435

 
 
 
 
Other comprehensive income (loss), net of tax:
 
 
 
Changes in foreign currency translation
(430
)
 
(3,487
)
Reclassification of gain on equity securities, net of taxes of $1 and $3,041, respectively
2

 
(4,757
)
Unrealized gain on marketable securities, net of taxes of $0 and $984, respectively

 
1,539

Minimum pension liability adjustment

 
(8
)
Reclassification of currency translation adjustment (CTA) write-off related to Japanese subsidiary to earnings
2,628

 

Reclassification of minimum pension liability to earnings
(344
)
 

Other comprehensive income (loss)
1,856

 
(6,713
)
 
 
 
 
Comprehensive (loss) income
$
(28,564
)
 
$
1,722


The accompanying notes are an integral part of these condensed consolidated financial statements.

3


WRIGHT MEDICAL GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)

 
Three Months Ended
 
March 31,
 
2014
 
2013
Operating activities:
 
 
 
Net (loss) income
$
(30,420
)
 
$
8,435

Adjustments to reconcile net (loss) income to net cash provided by operating activities:
 
 
 
Depreciation
4,346

 
8,945

Stock-based compensation expense
2,320

 
4,618

Amortization of intangible assets
2,187

 
2,097

Amortization of deferred financing costs and debt discount
2,676

 
2,510

Deferred income taxes
574

 
(569
)
Excess tax benefit from stock-based compensation arrangements

 
(30
)
Non-cash adjustments to derivative fair value
1,000

 
2,000

Non-cash realized gain on BioMimetic stock

 
(7,798
)
Gain on sale of OrthoRecon business
(24,277
)
 

Mark-to-market adjustment for CVRs (Note 1)
14,295



Other
570

 
(979
)
Changes in assets and liabilities (net of acquisitions and dispositions):
 
 
 
Accounts receivable
(1,493
)
 
(2,544
)
Inventories
(3,911
)
 
4,951

Prepaid expenses and other assets
4,776

 
(20,539
)
Accounts payable
6,747

 
3,060

Accrued expenses and other liabilities
(6,630
)
 
(9,325
)
Net cash used in operating activities
(27,240
)
 
(5,168
)
Investing activities:
 
 
 
Capital expenditures
(7,836
)
 
(3,740
)
Acquisition of businesses (Note 2)
(80,547
)
 
(40,398
)
Purchase of intangible assets
(755
)
 
(1,340
)
Sales and maturities of available-for-sale marketable securities
1,745

 
10,602

Investment in available-for-sale marketable securities

 
(13,149
)
Proceeds from sale of assets
278,602

 

Net cash provided by (used in) investing activities
191,209

 
(48,025
)
Financing activities:
 
 
 
Issuance of common stock
10,690

 
1,126

Payments of deferred financing and equity issuance costs

 
(16
)
Payments of capital leases
(26
)
 
(249
)
Excess tax benefit from stock-based compensation arrangements

 
30

Net cash provided by financing activities
10,664

 
891

Effect of exchange rates on cash and cash equivalents
484

 
(579
)
Net (decrease) increase in cash and cash equivalents
175,117

 
(52,881
)
Cash and cash equivalents, beginning of period
168,735

 
320,360

Cash and cash equivalents, end of period
$
343,852

 
$
267,479


The accompanying notes are an integral part of these condensed consolidated financial statements.

4


WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


1. Summary of Significant Accounting Policies
Basis of Presentation. The unaudited condensed consolidated interim financial statements of Wright Medical Group, Inc. have been prepared in accordance with accounting principles generally accepted in the United States (U.S.) for interim financial information and the instructions to Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the U.S. have been condensed or omitted pursuant to these rules and regulations. Accordingly, these unaudited condensed consolidated interim financial statements should be read in conjunction with our consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the U.S. Securities and Exchange Commission (SEC).
In the opinion of management, these unaudited condensed consolidated interim financial statements reflect all adjustments necessary for a fair presentation of our interim financial results. All such adjustments are of a normal and recurring nature. The results of operations for any interim period are not indicative of results for the full fiscal year. Certain prior year amounts have been reclassified to conform with the current year presentation, including amounts related to discontinued operations.
The accompanying unaudited condensed consolidated interim financial statements include our accounts and those of our domestic and international subsidiaries, all of which are wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.
The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the dates of the financial statements and the amounts of revenues and expenses during the reporting periods. Actual amounts realized or paid could differ from those estimates.

Income Taxes. In July 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exist” (ASU 2013-11). ASU 2013-11 reduces diversity in practice by providing guidance on the presentation of unrecognized tax benefits and is intended to better reflect the manner in which an entity would settle at the reporting date any additional income taxes that would result from the disallowance of a tax position when net operating loss carryforwards, similar tax losses, or tax credit carryforwards exist. We adopted ASU 2013-11 effective January 1, 2014, which resulted in an immaterial balance sheet reclassification to conform to the required “net” presentation.
Fair Value of Financial Instruments. The carrying values of cash and cash equivalents, accounts receivable, and accounts payable approximate the fair values of these financial instruments as of March 31, 2014 and December 31, 2013 due to their short maturities or variable rates.
The remaining outstanding $3.8 million of our 2.625% Convertible Senior Notes maturing on December 1, 2014 (2014 Notes) are carried at cost. The estimated fair value of these 2014 Notes was approximately $3.6 million at March 31, 2014, based on a limited number of trades (Level1) and does not necessarily represent the value at which the entire 2014 Note portfolio can be retired.
Our $300 million of our 2.00% Convertible Senior Notes maturing in 2017 (2017 Notes) are carried at cost, net of unamortized discount. The estimated fair value of our 2017 Notes was approximately $411.8 million at March 31, 2014, based on a quoted price in an active market (Level 1).
FASB Accounting Standards Codification (ASC) Topic 820, Fair Value Measurement, 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: 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.
Level 3: 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 debt 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

5

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


multiple prices as inputs into a pricing model to determine a weighted average price for each security. We have controls in place to review the third party provider's qualifications and procedures used to determine fair values and to validate the prices used in their determination of fair value. We classify our investment in U.S. Treasury bills and bonds and corporate equity securities 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 U.S. agency debt securities, certificates of deposit, commercial paper, and corporate debt securities.
During the third quarter of 2012, we issued $300 million of our 2017 Notes, and we have recorded a derivative liability for the conversion feature (2017 Notes Conversion Derivative) of such 2017 Notes. Additionally, we entered into convertible notes hedging transactions (2017 Notes Hedges) in connection with the issuance of our 2017 Notes. The 2017 Notes Hedges and the 2017 Notes Conversion Derivative are measured at fair value using Level 3 inputs. These instruments are not actively traded and are valued using an option pricing model that uses observable and unobservable market data for inputs.
To determine the fair value of the embedded conversion option in the 2017 Notes Conversion Derivative, a binomial lattice model was used. A binomial stock price lattice generates two probable outcomes of stock price - one up and another down. This lattice generates a distribution of stock price at the maturity date. Using this stock price lattice, a conversion option lattice was created where the value of the embedded conversion option was estimated. The conversion option lattice first calculates the possible conversion option values at the maturity date using the distribution of stock price, which equals to the maximum of (x) zero, if stock price is below the strike price, or (y) stock price less the strike price, if the stock price is higher than the strike price. The value of the 2017 Notes Conversion Derivative at the valuation date was estimated using the conversion option values at the maturity date by moving back in time on the lattice. Specifically, at each node, if our 2017 Notes are eligible for early conversion, the value at this node is the maximum of (i) the early conversion value, which is the stock price less the strike price, and (ii) the discounted and probability-weighted value from the two probable outcomes in the future. If our 2017 Notes are not eligible for early conversion, the value of the conversion option at this node equals to (ii). In the conversion option lattice, credit adjustment was applied in the model as the embedded conversion option is settled with cash instead of shares.

To estimate the fair value of the 2017 Notes Hedges, we used the Black-Scholes formula combined with credit adjustments, as the bank counterparties have credit risk and the call options are cash settled. We assumed that the call options will be exercised at the maturity since our common stock does not pay any dividends and management does not expect to declare dividends in the near term.

The following assumptions were used in the fair market valuations of the 2017 Notes Conversion Derivative and 2017 Notes Hedges as of March 31, 2014:
 
2017 Notes Conversion Derivative
2017 Notes Hedge
Stock Price Volatility (1)
32
%
32
%
Credit Spread for Wright (2)
2.0
%
N/A

Credit Spread for Bank of America, N.A. (3)
N/A

0.4
%
Credit Spread for Deutsche Bank AG (3)
N/A

0.5
%
Credit Spread for Wells Fargo Securities, LLC (3)
N/A

0.2
%

(1)
Volatility selected based on historical and implied volatility of common shares of Wright Medical Group, Inc.
(2)
Credit spread was estimated based on BVAL price from Bloomberg as of valuation date.
(3)
Credit spread of each bank is estimated using CDS curves. Source: Bloomberg.
As part of the acquisitions of EZ Concepts Surgical Device Corporation, d/b/a EZ FrameTM and CCI® Evolution Mobile Bearing Total Ankle Replacement system (CCI acquisition), completed in 2010 and 2011, respectively, we have recorded $0.4 million of contingent liabilities for potential future cash payments related to these transactions as of March 31, 2014. As part of the acquisition of WG Healthcare in 2013, we have recorded contingent consideration of approximately $1.5 million as of March 31, 2014. As part of the acquisition of Biotech International (Biotech) in 2013, we have recorded the estimated fair value of future contingent consideration of approximately $4.3 million as of March 31, 2014. As part of the acquisition of OrthoPro, L.L.C. (OrthoPro), we are obligated to pay contingent consideration upon the achievement of certain revenue milestones; therefore, we have recorded the fair value of future contingent consideration of approximately $2.9 million as of March 31, 2014. The fair value of the contingent consideration associated with each of the acquisitions noted above as of March 31, 2014, was determined using a discounted cash flow model and probability adjusted estimates of the future earnings and is classified in Level 3. Changes in the fair value of contingent consideration are recorded in "Other (income) expense, net" in our condensed consolidated statements of operations.

6

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


On March 1, 2013, as part of the acquisition of BioMimetic Therapeutics, Inc. (BioMimetic), we issued Contingent Value Rights (CVRs) as part of the merger consideration. Each CVR entitles its holder to receive additional cash payments of up to $6.50 per share, which are payable upon receipt of FDA approval of Augment® Bone Graft and upon achieving certain revenue milestones. The fair value of the CVRs outstanding at March 31, 2014 of $23.3 million was determined using the closing price of the security in the active market (Level 1). This change in the value of the CVR resulted in a $14.3 million expense for the quarter ended March 31, 2014, which was recorded in Other expense (income) in the condensed consolidated statement of operations.
The following table summarizes the valuation of our financial instruments measured at fair value on a recurring basis (in thousands):
 
Total
Quoted Prices
in Active
Markets
(Level 1)
Prices with
Other
Observable
Inputs
(Level 2)
Prices with
Unobservable
Inputs
(Level 3)
At March 31, 2014
 
 
 
 
Assets
 
 
 
 
Cash and cash equivalents
$
343,852

$
343,852

$

$

Available-for-sale marketable securities
 
 
 
 
U.S. agency debt securities
3,499


3,499


Corporate debt securities
5,157


5,157


U.S. government debt securities
4,090

4,090



Total available-for-sale marketable securities
12,746

4,090

8,656


 
 
 
 
 
2017 Notes Hedges
119,000



119,000

 
 
 
 
 
 Total
$
475,598

$
347,942

$
8,656

$
119,000

 
 
 
 
 
Liabilities
 
 
 
 
2017 Notes Conversion Derivative
$
114,000

$

$

$
114,000

Contingent consideration
9,139



9,139

Contingent consideration (CVRs)
23,264

23,264



 
 
 
 
 
 Total
$
146,403

$
23,264

$

$
123,139

 
Total
Quoted Prices
in Active
Markets
(Level 1)
Prices with
Other
Observable
Inputs
(Level 2)
Prices with
Unobservable
Inputs
(Level 3)
At December 31, 2013
 
 
 
 
Assets
 
 
 
 
Cash and cash equivalents
$
168,534

$
168,534

$

$

Available-for-sale marketable securities
 
 
 
 
U.S. agency debt securities
$
4,998

$

$
4,998

$

Certificate of deposit
245


245


Corporate debt securities
5,188


5,188


U.S. Government debt securities
4,117

4,117



Total available-for-sale marketable securities
14,548

4,117

10,431


 
 
 
 
 
2017 Notes Hedges
118,000



118,000

 
 
 
 
 
 Total
$
301,082

$
172,651

$
10,431

$
118,000

 
 
 
 
 
Liabilities
 
 
 
 
2017 Notes Conversion Derivative
$
112,000

$

$

$
112,000

Contingent consideration
6,237



6,237

Contingent consideration (CVR)
$
8,969

8,969

$

$

 Total
$
127,206

$
8,969

$

$
118,237


7

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)



The following is a roll forward of our assets and liabilities measured at fair value on a recurring basis using unobservable inputs (Level 3):
 
 
Balance at December 31, 2013
Transfers into Level 3
Gain/Losses included in Earnings
Currency
Settlements
Balance at March 31, 2014
 
 
 
 
 
 
 
 
2017 Notes Hedges
 
$
118,000


1,000



$
119,000

 
 
 
 
 
 
 
 
2017 Notes Conversion Derivative
 
$
(112,000
)

(2,000
)


$
(114,000
)
 
 
 
 
 
 
 
 
Contingent Consideration
 
$
(6,236
)
(2,906
)
11

(11
)
3

$
(9,139
)

2. Acquisitions
Solana Surgical, LLC
On January 30, 2014, we acquired 100% of the outstanding equity of Solana Surgical, LLC (Solana), a privately held Memphis, Tennessee orthopaedic company, for approximately $48.0 million in cash and $41.4 million of our common stock. The transaction enables us to add Solana's complementary extremity product portfolio to further accelerate growth opportunities in our global extremities business. The operating results from this acquisition are included in the condensed 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):
Cash and cash equivalents
 
$
416

Accounts receivable
 
2,366

Inventory
 
2,244

Prepaid and other current assets
 
372

Property, plant and equipment
 
398

Intangible assets
 
22,111

Accounts payable and accrued liabilities
 
(1,959
)
Total net assets acquired
 
$
25,948

 
 
 
Goodwill
 
63,524

 
 
 
Total purchase consideration
 
$
89,472

The above purchase price allocation is considered preliminary and is subject to revision when the valuation of intangible assets is finalized upon receipt of the final valuation report for those assets from a third party valuation expert.
The goodwill is primarily attributable to strategic opportunities that arose from the acquisition of Solana. The goodwill is expected to be deductible for tax purposes.
Of the $22.1 million of acquired intangible assets, $12.1 million was assigned to purchased technology (10 year life), $9.4 million was assigned to customer relationships (12 year life), and $0.6 million was assigned to trademarks (2 year life).
The acquired business contributed revenues of $2.4 million and operating income of $0.4 million, which excludes transaction and transition costs, to our consolidated results from the date of acquisition through March 31, 2014.
OrthoPro, L.L.C.
On February 5, 2014, we acquired 100% of the outstanding equity of OrthoPro, a privately held Salt Lake City, Utah orthopaedic company, for approximately $33.0 million in cash plus contingent consideration with an estimated fair value of $2.9 million to be

8

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


paid upon the achievement of certain revenue milestones in 2014 and 2015. The transaction enables us to add OrthoPro's complementary extremity product portfolio to further accelerate growth opportunities in our global extremities business. The operating results from this acquisition are included in the condensed 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):
Cash and cash equivalents
 
$
98

Accounts receivable
 
1,308

Inventory
 
2,156

Prepaid and other current assets
 
49

Property, plant and equipment
 
1,950

Intangible assets
 
9,593

Accounts payable and accrued liabilities
 
(544
)
Total net assets acquired
 
$
14,610

 
 
 
Goodwill
 
21,332

 
 
 
Total purchase consideration
 
$
35,942

The above purchase price allocation is considered preliminary and is subject to revision when the valuation of intangible assets is finalized upon receipt of the final valuation report for those assets from a third party valuation expert.
The goodwill is primarily attributable to strategic opportunities that arose from the acquisition of OrthoPro. The goodwill is expected to be deductible for tax purposes.
Of the $9.6 million of acquired intangible assets, $4.8 million was assigned to customer relationships (12 year life), $4.6 million was assigned to purchased technology (10 year life), and $0.2 million was assigned to trademarks (2 year life).
The acquired business contributed revenues of $1.1 million and operating income of $0.3 million, which excludes transaction and transition costs, to our consolidated results from the date of acquisition through March 31, 2014.
Our consolidated results of operations would not have been materially different than reported results had both the OrthoPro and Solana acquisitions occurred at the beginning of 2013 and therefore, pro forma financial information has not been presented.
Biotech International
On November 15, 2013, we acquired 100% of the outstanding equity shares of Biotech International (Biotech), a leading, privately held French orthopaedic extremities company, for approximately $55.0 million in cash and $21.0 million of our common stock, plus additional contingent consideration with an estimated acquisition date fair value of $4.3 million to be paid upon the achievement of certain revenue milestones in 2014 and 2015. All of our common stock issued in connection with the transaction is subject to a lockup period of one year. The transaction will significantly expand our direct sales channel in France and international distribution network and add Biotech’s complementary extremity product portfolio to further accelerate growth opportunities in our global extremities business. The operating results from this acquisition are included in the condensed consolidated financial statements from the acquisition date.

9

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


The acquisition was recorded by allocating the costs of the assets and liabilities 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 net assets and liabilities acquired is recorded as goodwill. The following is a summary of the estimated fair values of the assets acquired (in thousands):
Cash and cash equivalents
 
$
252

Accounts receivable
 
5,400

Inventory
 
5,814

Prepaid and other current assets
 
303

Property, plant and equipment
 
2,573

Intangible assets
 
17,800

Accounts payable and accrued liabilities
 
(2,091
)
Deferred tax liability - current
 
(52
)
Deferred tax liability - noncurrent
 
(4,705
)
       Net assets acquired
 
$
25,294

 
 
 
Goodwill
 
54,955

 
 
 
Total purchase consideration
 
$
80,249

The purchase price allocation was adjusted in the first quarter of 2014 for the finalization of the valuation of our intangible assets. Intangible assets, net of tax, increased $1.5 million during the first quarter of 2014. The above purchase price allocation is considered preliminary and is subject to revision when we confirm tax related liabilities as of the date of acquisition.
The goodwill is attributable to the workforce of the acquired business and strategic opportunities that arose from the acquisition of Biotech. The goodwill is not expected to be deductible for tax purposes.
Of the estimated $17.8 million of acquired intangible assets, $10.1 million was assigned to customer relationships (12 year life), $7.1 million was assigned to purchased technology (10 year life), and $0.6 million was assigned to trademarks (2 year life).
The acquired business contributed revenues of $4.5 million and operating loss of $0.5 million, which excludes transaction and transition costs, to our consolidated results during 2014. Our consolidated results of operations would not have been materially different than reported results had the Biotech acquisition occurred at the beginning of 2013 and therefore, pro forma financial information has not been presented.

3. Discontinued Operations
On January 9, 2014, pursuant to the previously disclosed Asset Purchase Agreement, dated as of June 18, 2013 (the Purchase Agreement), by and among us, MicroPort Scientific Corporation, a corporation formed under the laws of the Cayman Islands (MicroPort), and MicroPort Medical B.V., a besloten vennootschap formed under the laws of the Netherlands, we completed our divesture and sale of our business operations operating under the OrthoRecon operating segment (the OrthoRecon Business) to MicroPort. Pursuant to the terms of the Asset Purchase Agreement, the purchase price (as defined in the Purchase Agreement) for the OrthoRecon Business was approximately $285 million (including an estimated working capital target adjustment), which MicroPort paid in cash. As a result of the transaction, we recognized approximately $24.3 million as the gain on disposal of the OrthoRecon business, before the effect of income taxes. As of March 31, 2014, the working capital target adjustment to the purchase price has not been finalized, and changes to our estimated working capital adjustment may impact the ultimate gain from the disposition of OrthoRecon business.

10


All current and historical operating results for the OrthoRecon segment are reflected within discontinued operations in the condensed consolidated financial statements. In addition, costs associated with corporate employees and infrastructure transferred as a part of the sale have been included in discontinued operations. The following table summarizes the results of discontinued operations (in thousands):
 
Three Months Ended
 
March 31
 
2014
 
2013
Revenue
$
2,942

 
$
64,062

Income before tax (including $24.3 million gain from disposal)
15,334

 
21,361

Income tax provision
15,456

 
8,008

(Loss) income from discontinued operations, net of tax
(122
)
 
13,353

The 2014 effective tax rate within the results of discontinued operations reflects the sale of non-deductible goodwill of $25.8 million associated with the OrthoRecon segment.
Certain liabilities associated with the OrthoRecon business, including product liability claims associated with hip and knee products sold prior to the closing, were not assumed by MicroPort. Liabilities associated with these product liability claims, including legal defense, settlements and judgments, income associated with product liability insurance recoveries, and changes to any contingent liabilities associated with the OrthoRecon business have been reflected within results of discontinued operations, and we will continue to reflect these within results of discontinued operations in future periods. We will incur continuing cash outflows associated with legal defense costs and the ultimate resolution of these contingent liabilities, net of insurance proceeds, until these liabilities are resolved.
MicroPort is responsible for product liability claims associated with products it sells after the closing.

4. Inventories
Inventories consist of the following (in thousands):
 
March 31,
2014
December 31,
2013
Raw materials
$
3,577

$
2,693

Work-in-process
7,458

6,950

Finished goods
67,798

62,800

 
$
78,833

$
72,443


5. Marketable Securities
Our investments in 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. 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 March 31, 2014 and December 31, 2013, we had current marketable securities totaling $9.2 million and $6.9 million, respectively, consisting of investments in corporate and government bonds, all of which are valued at fair value using a market approach. In addition, we had non-current marketable securities totaling $3.5 million and $7.7 million as of March 31, 2014 and December 31, 2013, respectively, consisting of investments in corporate, government, and agency bonds, all of which are valued at fair value using a market approach.

11

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


The following tables present a summary of our marketable securities (in thousands):
 
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Estimated
Fair Value
At March 31, 2014
 
 
 
 
Available-for-sale marketable securities
 
 
 
 
U. S. agency debt securities
$
3,500

$

$
(1
)
$
3,499

Corporate debt securities
5,155

2


5,157

U.S. government debt securities
4,087

3


4,090

Total available-for-sale marketable securities
$
12,742

$
5

$
(1
)
$
12,746


 
Amortized Cost
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Estimated
Fair Value
At December 31, 2013
 
 
 
 
Available-for-sale marketable securities
 
 
 
 
U.S. agency debt securities
$
5,002

$

$
(4
)
$
4,998

Certificate of deposit
245



245

Corporate debt securities
5,186

2


5,188

U.S. government debt securities
4,116

1


4,117

Total available-for-sale marketable securities
$
14,549

$
3

$
(4
)
$
14,548


The maturities of available-for-sale debt securities at March 31, 2014 are as follows:
 
Available-for-Sale
 
Cost Basis
Fair Value
Due in one year or less
$
9,242

$
9,247

Due after one year through two years
3,500

3,499

 
$
12,742

$
12,746


6. Property, Plant and Equipment, Net
Property, plant and equipment consist of the following (in thousands):
 
March 31,
2014
December 31,
2013
Property, plant and equipment, at cost
$
152,979

$
141,585

Less: Accumulated depreciation
(77,378
)
(71,070
)
 
$
75,601

$
70,515


7. Long-Term Debt and Capital Lease Obligations
Long-term debt and capital lease obligations consist of the following (in thousands):
 
March 31,
2014
December 31,
2013
Capital lease obligations
$
8,231

$
8,238

2017 Notes
265,654

263,395

2014 Notes
3,768

3,768

 
277,653

275,401

Less: current portion
(4,382
)
(4,174
)
 
$
273,271

$
271,227

2017 Notes
On August 31, 2012, we issued $300 million aggregate principal amount of the 2017 Notes pursuant to an indenture, dated as of August 31, 2012 between us and The Bank of New York Mellon Trust Company, N.A., as Trustee. The 2017 Notes will mature on August 15, 2017, and we pay interest on the 2017 Notes semi-annually on each February 15 and August 15 at an annual rate

12

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


of 2.00%. We may not redeem the 2017 Notes prior to the maturity date, and no “sinking fund” is available for the 2017 Notes, which means that we are not required to redeem or retire the 2017 Notes periodically. The 2017 Notes are convertible at the option of the holder, during certain periods and subject to certain conditions as described below, solely into cash at an initial conversion rate of 39.3140 shares per $1,000 principal amount of the 2017 Notes, subject to adjustment upon the occurrence of specified events, which represents an initial conversion price of $25.44 per share. The holder of the 2017 Notes may convert their notes at any time prior to February 15, 2017 only under the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending December 31, 2012 (and only during such calendar quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (2) during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events. On or after February 15, 2017 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their 2017 Notes solely into cash, regardless of the foregoing circumstances. Upon conversion, a holder will receive an amount in cash, per $1,000 principal amount of the 2017 Notes, equal to the settlement amount as calculated under the indenture relating to the 2017 Notes. If we undergo a fundamental change, as defined in the indenture relating to the 2017 Notes, subject to certain conditions, holders of the 2017 Notes will have the option to require us to repurchase for cash all or a portion of their notes at a purchase price equal to 100% of the principal amount of the 2017 Notes to be repurchased, plus any accrued and unpaid interest to, but excluding, the fundamental change repurchase date, as defined in the indenture relating to the 2017 Notes. In addition, following certain corporate transactions, we, under certain circumstances, will pay a cash make-whole premium by increasing the applicable conversion rate for a holder that elects to convert its 2017 Notes in connection with such corporate transaction. The 2017 Notes are senior unsecured obligations that rank: (i) senior in right of payment to any of our indebtedness that is expressly subordinated in right of payment to the 2017 Notes; (ii) equal in right of payment to any of our unsecured indebtedness that is not so subordinated; (iii) effectively junior in right of payment to any secured indebtedness to the extent of the value of the assets securing such indebtedness; and (iv) structurally junior to all indebtedness and other liabilities (including trade payables) of our subsidiaries. As a result of this transaction, we recognized deferred financing charges of approximately $8.8 million, which are being amortized over the term of the 2017 Notes using the effective interest method.
The 2017 Notes Conversion Derivative requires bifurcation from the 2017 Notes in accordance with ASC Topic 815, Derivatives and Hedging, and is accounted for as a derivative liability. The fair value of the 2017 Notes Conversion Derivative at the time of issuance of the 2017 Notes was $48.1 million and was recorded as original debt discount for purposes of accounting for the debt component of the 2017 Notes. This discount is amortized as interest expense using the effective interest method over the term of the 2017 Notes. For the three months ended March 31, 2014, the Company recorded $2.3 million of interest expense related to the amortization of the debt discount based upon an effective rate of 6.47%.
The components of the 2017 Notes were as follows (in thousands):
 
March 31, 2014
December 31, 2013
Principal amount of 2017 Notes
$
300,000

$
300,000

Unamortized debt discount
(34,346
)
(36,605
)
Net carrying amount of 2017 Notes
$
265,654

$
263,395

We entered into 2017 Notes Hedges in connection with the issuance of the 2017 Notes with three counterparties (the Option Counterparties). The 2017 Notes Hedges, which are cash-settled, are intended to reduce our exposure to potential cash payments that we would be required to make if holders elect to convert the 2017 Notes at a time when our stock price exceeds the conversion price. The aggregate cost of the 2017 Notes Hedges was $56.2 million and is accounted for as a derivative asset in accordance with ASC Topic 815. See Note 8 of the condensed consolidated financial statements for additional information regarding the 2017 Notes Hedges and the 2017 Notes Conversion Derivative.
We also entered into warrant transactions in which we sold warrants for an aggregate of 11.8 million shares of our common stock to the Option Counterparties, subject to adjustment. The strike price of the warrants was initially $29.925 per share, which was 50% above the last reported sale price of our common stock on August 22, 2012. The warrants are net-share settled and are exercisable over the 100 trading day period beginning on November 15, 2017. The warrant transactions will have a dilutive effect to the extent that the market value per share of our common stock during such period exceeds the applicable strike price of the warrants.
Aside from the initial payment of the $56.2 million premium to the Option Counterparties, we will not be required to make any cash payments to the Option Counterparties under the 2017 Notes Hedges and will be entitled to receive from the Option Counterparties cash, generally equal to the amount by which the market price per share of common stock exceeds the strike price

13

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


of the convertible note hedging transactions during the relevant valuation period. The strike price under the 2017 Notes Hedges is equal to the conversion price of the 2017 Notes. Additionally, if the market value per share of our common stock exceeds the strike price on any day during the 100 trading day measurement period under the warrant transaction, we will be obligated to issue to the Option Counterparties a number of shares equal in value to one percent of the amount by which the then-current market value of one share of our common stock exceeds the then-effective strike price of each warrant, multiplied by the number of shares of common stock into which the 2017 Notes are then convertible at or following maturity. We will not receive any additional proceeds if warrants are exercised.

2014 Notes
In November 2007, we issued $200 million of 2.625% Convertible Senior Notes maturing on December 1, 2014 (2014 Notes). The 2014 Notes pay interest semi-annually 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 2014 Notes may convert at any time on or prior to the close of business on the business day immediately preceding the maturity date. Beginning on December 6, 2011, we may redeem the 2014 Notes, in whole or in part, at a redemption price equal to 100% of the principal amount of the 2014 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 2014 Notes (Indenture), the holders may require us to purchase for cash all or a portion of the 2014 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 2014 Notes, we may, under certain circumstances, increase the conversion rate for the 2014 Notes surrendered. The 2014 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 2014 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 2014 Notes. Upon expiration on March 11, 2011, we purchased $170.9 million aggregate principal amount of the 2014 Notes.
On August 22, 2012, we purchased $25.3 million aggregate principal amount of the 2014 Notes. As a result of this transaction, we recognized approximately $0.2 million for the write off of related pro-rata unamortized deferred financing fees. As of March 31, 2014, $3.8 million aggregate principal amount of the 2014 Notes remain outstanding and is classified in the current portion of long-term obligations line on the condensed consolidated balance sheet.

8. Derivative Instruments and Hedging Activities
We account for derivatives in accordance with FASB Accounting Standard Codification (ASC) Topic 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.
Conversion Derivative and Notes Hedging
On August 31, 2012, we issued the 2017 Notes. The 2017 Notes Conversion Derivative requires bifurcation from the 2017 Notes in accordance with ASC Topic 815, and is accounted for as a derivative liability. The fair value of the 2017 Notes Conversion Derivative at the time of issuance of the 2017 Notes was $48.1 million. See Note 7 of the condensed consolidated financial statements for additional information regarding the 2017 Notes.
We also entered into the 2017 Notes Hedges in connection with the issuance of the 2017 Notes with the Option Counterparties. The 2017 Notes Hedges, which are cash-settled, are intended to reduce our exposure to potential cash payments that we are required to make upon conversion of the 2017 Notes in excess of the principal amount of converted notes if our common stock price exceeds the conversion price. The aggregate cost of the 2017 Notes Hedges was $56.2 million and is accounted for as a derivative asset in accordance with ASC Topic 815.
The following table summarizes the fair value and the presentation in the condensed consolidated balance sheet (in thousands):
 
Location on condensed consolidated balance sheet
March 31, 2014
December 31, 2013
2017 Notes Hedges
Other assets
$
119,000

$
118,000

2017 Notes Conversion Derivative
Other liabilities
$
114,000

$
112,000


14

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


Neither the 2017 Notes Conversion Derivative nor the 2017 Notes Hedges qualify for hedge accounting, thus any change in the fair value of the derivatives is recognized immediately in the consolidated statements of operations. The following table summarizes the gain (loss) on changes in fair value (in thousands):
 
Three Months Ended
 
March 31,
 
2014
2017 Notes Hedges
$
1,000

2017 Notes Conversion Derivative
(2,000
)
Net loss on changes in fair value
$
(1,000
)
Derivatives not Designated as Hedging Instruments
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 Topic 815. Accordingly, the changes in the fair value and the settlement of the contracts are recognized in the period incurred in the accompanying condensed consolidated statements of operations. At March 31, 2014, we had no foreign currency contracts outstanding.

9. Goodwill and Intangible Assets
Changes in the carrying amount of goodwill occurring during the three months ended March 31, 2014, are as follows (in thousands):
 
U.S.
International
BioMimetic
Total
Goodwill at December 31, 2013
$
92,134

$
24,746

$
1,383

$
118,263

Biotech intangible valuation adjustment
(1,197
)
(323
)
(15
)
(1,535
)
Goodwill associated with acquisitions (see Note 2)
84,856



84,856

Foreign currency translation

41


41

Goodwill at March 31, 2014
$
175,793

$
24,464

$
1,368

$
201,625

During the first quarter of 2014, we revised the estimated fair value of intangible assets acquired as part of the 2013 acquisition of Biotech, which resulted in a change in the preliminary value of goodwill determined as of December 31, 2013.
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.
During the first quarter of 2014, our management, including our chief executive officer, who is our chief operating decision maker, began managing our operations as three operating segments: U.S., International and BioMimetic, based on management's change to the way it monitors performance, aligns strategies, and allocates resources. We determined that each of these operating segments represented a reportable segment. This change in segment reporting has also resulted in a change in reporting units for goodwill impairment measurement purposes. We determined that each operating segment represents a reporting unit, and we subsequently performed a goodwill impairment analysis as of January 1, 2014. We allocated $90.9 million, $24.4 million and $1.4 million of goodwill to the U.S., International and BioMimetic reporting units, respectively, as of January 1, 2014. The goodwill allocated to each reporting unit was based on the relative fair value of each of our reporting units as of the date of impairment analysis. Upon completion of this analysis, we determined that the fair value of our reporting units exceeded their carrying values and, therefore, no impairment charge was necessary.

15

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


The components of our identifiable intangible assets are as follows (in thousands):
 
March 31, 2014
December 31, 2013
 
Cost
Accumulated Amortization
Cost
Accumulated Amortization
Indefinite life intangibles
 
 
 
 
IPRD Technology
$
4,266

 
$
4,266

 
Tradename
4,134

 
4,121

 
Total indefinite life intangibles
8,400

 
8,387

 
 
 
 
 
 
Finite life intangibles
 
 
 
 
 Distribution channels
250

175

250

233

 Completed technology
35,813

6,531

16,714

5,702

 Licenses
3,633

1,369

3,633

1,303

 Customer relationships
30,062

2,925

15,578

2,371

 Trademarks
2,867

1,252

2,364

1,098

 Non-compete agreements
7,312

4,389

5,660

3,155

 Other
770

88

771

75

Total finite life intangibles
80,707

$
16,729

44,970

$
13,937

 
 
 
 
 
Total intangibles
89,107

 
53,357

 
Less: Accumulated amortization
(16,729
)
 
(13,937
)
 
Intangible assets, net
$
72,378

 
$
39,420

 
Based on total finite life intangible assets held at March 31, 2014, we expect to amortize approximately $10.3 million for the full year of 2014, $8.0 million in 2015, $6.5 million in 2016, $6.3 million in 2017, and $5.6 million in 2018.

10. Accumulated Other Comprehensive Income (AOCI)
Other comprehensive income (OCI) includes certain gains and losses that under GAAP are included in comprehensive income but are excluded from net income as these amounts are initially recorded as an adjustment to stockholders’ equity. Amounts in OCI may be reclassified to net income upon the occurrence of certain events.
Our OCI is comprised of foreign currency translation adjustments, unrealized gains and losses on available-for-sale securities, and adjustments to our minimum pension liability. Foreign currency translation adjustments are reclassified to net income upon sale or upon a complete or substantially complete liquidation of an investment in a foreign entity. Unrealized gains and losses on available-for-sale securities are reclassified to net income if we sell the security before maturity or if the unrealized loss in a security is considered to be other-than-temporary.
Changes in and reclassifications out of AOCI, net of tax, for the three months ended March 31, 2014 were as follows (in thousands):
 
Currency Translation Adjustment (CTA)
 
Unrealized
Gain(Loss) on
Marketable Securities
 
Minimum
Pension
Liability
Adjustment
 
Total
Balance December 31, 2013
$
17,610

 
$
(1
)
 
$
344

 
$
17,953

Other comprehensive income (loss), net of tax
(430
)
 
2

 

 
(428
)
Reclassification of CTA and minimum pension liability adjustment 1
2,628

 

 
(344
)
 
2,284

Balance March 31, 2014
$
19,808

 
$
1

 
$

 
$
19,809

            


16

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


1 
The balances of CTA and minimum pension liability adjustment within AOCI was written-off following the liquidation of our former Japanese subsidiary as part of the sale of our OrthoRecon business. This was recorded within the gain on the sale of the OrthoRecon business within results of discontinued operations.

11. Earnings Per Share
FASB ASC Topic 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, 2014 Notes, and warrants. The dilutive effect of the stock options, non-vested shares of common stock, stock-settled phantom stock units, restricted stock units and warrants is calculated using the treasury-stock method. The dilutive effect of 2014 Notes 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. During the three month period ended March 31, 2014, the 2014 Notes had an anti-dilutive effect on earnings per share and we therefore excluded it from the dilutive shares calculation. During the three month period ended March 31, 2013, the 2014 Notes had a dilutive effect on earnings per share and we therefore excluded it in the dilutive shares calculation. In addition, approximately 1.9 million common stock equivalents have been excluded from the computation of diluted net loss from continuing operations per share for the three month period ended March 31, 2014 because their effect is anti-dilutive as a result of our net loss in that period.
The weighted-average number of shares outstanding for basic and diluted earnings per share is as follows (in thousands):
 
Three Months Ended
 
March 31,
 
2014
 
2013
Weighted-average number of shares outstanding, basic
48,625

 
41,438

Common stock equivalents

 
701

Weighted-average number of shares outstanding, diluted
48,625

 
42,139


The following potential common shares were excluded from common stock equivalents as their effect would have been anti-dilutive (in thousands):
 
Three Months Ended
 
March 31,
 
2014
 
2013
Stock options
159

 
2,723

Non-vested shares, restricted stock units, and stock-settled phantom stock units
31

 

2014 Notes
115

 

Warrants

 
11,794


12. Commitments and Contingencies
Legal Contingencies
As described below, our business is subject to various contingencies, including patent and other litigation, product liability claims and a government inquiry.  These contingencies could result in losses, including damages, fines, or penalties, any of which could be substantial, as well as criminal charges. Although such matters are inherently unpredictable, and negative outcomes or verdicts can occur, we believe we have significant defenses in all of them, are vigorously defending all of them, and do not believe any of them will have a material adverse effect on our financial position. However, we could incur judgments, pay settlements, or revise our expectations regarding the outcome of any matter. Such developments, if any, could have a material adverse effect on our results of operations in the period in which applicable amounts are accrued, or on our cash flows in the period in which amounts are paid.
Our contingencies are subject to significant uncertainties and, therefore, determining the likelihood of a loss or the measurement of a loss can be complex. We have accrued for losses that are both probable and reasonably estimable. Unless otherwise indicated, we are unable to estimate the range of reasonably possible loss in excess of amounts accrued.  Our assessment process relies on estimates and assumptions that may prove to be incomplete or inaccurate. Unanticipated events and circumstances may occur that could cause us to change our estimates and assumptions.

17

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


Governmental Inquiries
On September 29, 2010, we 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). The CIA was filed as Exhibit 10.2 to our current report on Form 8-K filed on September 30, 2010. The CIA will expire on September 29, 2015.
The CIA imposes on us certain obligations 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, potential prosecution, civil and criminal fines or penalties, as well as additional litigation cost and expense.
Both we and MicroPort, who purchased our OrthoRecon business in January 2014, will continue to be subject to the CIA.
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 CIA. In addition, the matters that gave rise to the CIA could increase our exposure to lawsuits by potential whistleblowers, including under the federal false claims acts, based on new theories or allegations arising from these matters.
On August 3, 2012, we received a subpoena from the U.S. Attorney's Office for the Western District of Tennessee requesting records and documentation relating to our PROFEMUR® series of hip replacement devices. The subpoena covers the period from January 1, 2000 to August 2, 2012. We continue to respond to the subpoena.
Patent Litigation.
In 2011, Howmedica Osteonics Corp. (Howmedica) and Stryker Ireland, Ltd. (collectively, “Stryker”), each a subsidiary of Stryker Corporation, filed a lawsuit against Wright Medical Technology, Inc. (WMT) in the United States District Court for the District of New Jersey (District Court) alleging that we infringed 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. On July 9, 2013, the district court issued a claim construction ruling. Under the court's claim construction ruling, we do not believe these hip products infringe the asserted patents. In filings with the court, Stryker has conceded that under the court’s claim construction rulings it can no longer pursue its infringement claims. Stryker has asked the court to dismiss the case so it may pursue an appeal.
In 2012, Bonutti Skeletal Innovations, LLC (Bonutti) filed a patent infringement lawsuit against us in the United States Court for the District of Delaware. In January 2014, we filed a request with the U.S. Patent and Trademark Office for Inter Partes Review (IPR) of the Bonutti patents. On April 7, 2014, the Court stayed the case pending outcome of the IPR. Bonutti originally alleged that the Link Sled Prosthesis infringes U.S. Patent 6,702,821. The Link Sled Prosthesis is a product we distributed under a distribution agreement with LinkBio Corp, which expired on December 31, 2013. In January 2013, Bonutti amended its complaint, alleging that the ADVANCE® knee system, including ODYSSEY® instrumentation, infringes U.S. Patent 8,133,229, and that the ADVANCE® knee system, including ODYSSEY® instrumentation and PROPHECY® guides, infringes U.S. Patent 7,806,896, which was issued on October 5, 2010. All of the claims of the asserted patents are directed to surgical methods for minimally invasive surgery.
In June 2013, Orthophoenix filed a patent lawsuit against us in the United States District Court for the District of Delaware alleging that surgical methods using the X-REAM® product infringe two patents.
In June 2013, Anglefix filed suit in the United States District Court for the Western District of Tennessee, alleging that our ORTHOLOC® products infringe Anglefix’s asserted patent. On April 14, 2014, we filed a request for IPR with the U.S. Patent and Trademark Office.
In September 2013, ConforMIS, Inc. filed suit against us in the United States District Court for the District of Massachusetts, alleging that our PROPHECY® knee and ankle systems infringe four ConforMIS’ patents. On February 19, 2014, ConforMIS filed an amended complaint asserting four additional patents against us relating to alleged infringement by our PROPHECY® knee and ankle systems and naming MicroPort Orthopedics as an additional defendant.
Subject to the provisions of the asset purchase agreement with MicroPort for the sale of our OrthoRecon business, we will continue to be responsible for defense of pre-existing patent infringement cases relating to our OrthoRecon business, and for resulting liabilities, if any.
Product Liability
We have received claims for personal injury against us associated with fractures of our PROFEMUR® long titanium modular neck product (PROFEMUR® Claims). The overall fracture rate for the product is low and the fractures appear, at least in part, to relate to patient demographics. Beginning in 2009, we began offering a cobalt-chrome version of our PROFEMUR® modular neck,

18

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


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 quarter ended September 30, 2011, as a result of an increase in the number and monetary amount of these claims, management estimated our liability to patients in North America who have previously required a revision following a fracture of a PROFEMUR® long titanium modular neck, or who may require a revision in the future. Management has estimated that this aggregate liability ranges from approximately $17 million to $28 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 $16.6 million, which represents the low-end of our estimated aggregate range of loss. We have classified $9 million of this liability as current in “Accrued expenses and other current liabilities” and $7.6 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 have maintained product liability insurance coverage on a claims-made basis. During the quarter ended March 31, 2013, we received a customary reservation of rights from our primary product liability insurance carrier asserting that present and future claims related to fractures of our PROFEMUR® titanium modular neck hip products and which allege certain types of injury (Modular Neck Claims) would be covered as a single occurrence under the policy year the first such claim was asserted. The effect of this coverage position would be to place Modular Neck Claims into a single prior policy year in which applicable claims-made coverage was available, subject to the overall policy limits then in effect. Management agrees with the assertion that the Modular Neck Claims should be treated as a single occurrence, but notified the carrier that it disputed the carrier's selection of available policy years. During the second quarter of 2013, we received confirmation from the primary carrier confirming their agreement with our policy year determination. Based on our insurer's treatment of Modular Neck Claims as a single occurrence, we increased our estimate of the total probable insurance recovery related to Modular Neck Claims by $19.4 million, and recognized such additional recovery as a reduction to our selling, general and administrative expenses for the three-months ended March 31, 2013, within results of discontinued operations. In the quarter ended June 30, 2013, we received payment from the primary insurance carrier of $5 million. In the quarter ended September 30, 2013, we received payment of $10 million from the next insurance carrier in the tower. As of March 31, 2014, our insurance receivable related to Modular Neck Claims totals $25 million, which consists of $10 million associated with our recorded liability for current and future Modular Neck Claims outstanding, and $15 million for cash spending to date associated with defense and settlement costs. We have classified $25 million within current receivables.
During the quarter ended September 30, 2013, we reached the maximum insurance coverage for Modular Neck Claims of $40 million, when previous spending on legal defense costs and claim settlements are combined with our estimated product liability for future settlements. As a result, we recognized approximately $3.7 million of expense within results from discontinued operations for 2014 for legal expenses and adjustments to our estimated liabilities for future settlements recognized in excess of the $40 million insurance recovery limit. Future expenses associated with defense costs and revisions to our estimated product liability will be recognized as incurred within results of discontinued operations. As noted above, our insurance receivable for cash spending is $15 million out of the remaining $25 million insurance receivable. We do not anticipate actual cash spending to exceed this maximum for a few years.
Claims for personal injury have also been made against us associated with our metal-on-metal hip products (primarily our CONSERVE® product line). The pre-trial management of certain of these claims has been consolidated in the federal court system under multi-district litigation, and certain other claims in state courts in California, collectively the “Consolidated Metal-on-Metal Claims,” as further discussed in Part II Item 1 of this Quarterly Report. The number of these lawsuits, presently in excess of 700, continues to increase, we believe due to the increasing negative publicity in the industry regarding metal-on-metal hip products. We have also entered into an excess of 400 so called "tolling agreements" with potential claimants who have not yet filed suit. We believe we have data that supports the efficacy and safety of our metal-on-metal hip products. While continuing to dispute liability, we recently agreed to participate in court supervised non-binding mediation in the multi-district federal court litigation presently pending in the Northern District of Georgia.
Every metal-on-metal hip case involves fundamental issues of science and medicine that often are uncertain, that continue to evolve, and which present contested facts and issues that can differ significantly from case to case. Such contested facts and issues include medical causation, individual patient characteristics, surgery specific factors, and the existence of actual, provable injury. Given these complexities, we are unable to reasonably estimate a possible loss or range of possible losses for the Consolidated Metal-on-Metal Claims until we know, at a minimum, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential pool of potential claimants, particularly when damages are not specified

19

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (iv) any other factors that may have a material effect on the litigation or on a party’s litigation strategy.
We have maintained product liability insurance coverage on a claims-made basis. During the quarter ended September 30, 2012, we received a customary reservation of rights from our primary product liability insurance carrier asserting that certain present and future claims which allege certain types of injury related to our CONSERVE® metal-on-metal hip products (CONSERVE® Claims) would be covered as a single occurrence under the policy year the first such claim was asserted. The effect of this coverage position would be to place CONSERVE® Claims into a single prior policy year in which applicable claims-made coverage was available, subject to the overall policy limits then in effect. Management agrees that there is insurance coverage for the CONSERVE® Claims, but has notified the carrier that at this time it disputes the carrier's selection of available policy years and its characterization of the CONSERVE® Claims as a single occurrence.
Management has recorded an insurance receivable for the probable recovery of spending in excess of our retention for a single occurrence. As of March 31, 2014, this receivable totaled $8.5 million, and is solely related to defense costs incurred through March 31, 2014. However, the amount we ultimately receive may differ depending on the final conclusion of the insurance policy year or years and the number of occurrences. We believe our contracts with the insurance carriers are enforceable for these claims and, therefore, we believe it is probable that we will receive recoveries from our insurance carriers. However, our insurance carriers could still ultimately deny coverage for some or all of our insurance claims. Based on the information we have available at this time, we do not believe our liabilities, if any, in connection with these matters will exceed our available insurance. As circumstances continue to develop, our belief that we will be able to resolve the Consolidated Metal-on-Metal Claims within our available insurance coverage could change, which could materially impact our results of operations and financial position.
In February 2014, Biomet, Inc. (Biomet) announced it had reached a settlement in the multi-district litigation involving its own metal-on-metal hip products. The terms announced by Biomet include: (i) an expected base settlement amount of $200,000, (ii) an expected minimum settlement amount of $20,000, (iii) no payments to plaintiffs who did not undergo a revision surgery, and (iv) a total settlement amount expected to be within Biomet’s aggregate insurance coverage. We believe our situation involves facts and circumstances that differ significantly from the Biomet cases. We therefore do not consider the Biomet situation sufficiently analogous to provide a reasonable basis for estimate, and deem it unlikely that any settlement of our cases will occur at a base settlement level as high as Biomet’s expected average settlement amount.
In addition to the Consolidated Metal-on-Metal Claims discussed above, there are currently certain other pending claims related to our metal-on-metal hip products for which we are accounting in accordance with our standard product liability accrual methodology on a case by case basis.
Certain liabilities associated with the OrthoRecon business, including product liability claims associated with hip and knee products sold prior to the closing, were not assumed by MicroPort. Liabilities associated with these product liability claims, including legal defense, settlements and judgments, income associated with product liability insurance recoveries, and changes to any contingent liabilities associated with the OrthoRecon business have been reflected within results of discontinued operations, and we will continue to reflect these within results of discontinued operations in future periods. MicroPort is responsible for product liability claims associated with products it sells after the closing.
Employment Litigation
In 2012, two former employees, Frank Bono and Alicia Napoli, each filed separate lawsuits against WMT in the Chancery Court of Shelby County, Tennessee, which asserted 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. Bono and Ms. Napoli each claimed that he or she was entitled to attorney fees in addition to other unspecified damages. On October 23, 2013, Ms. Napoli moved to voluntary dismiss her lawsuit, without prejudice. On April 4, 2014, Ms. Napoli refiled her case in the United States District Court for the Eastern District of Missouri.
Securities Litigation
On July 6, 2011, a purported federal securities class action lawsuit was filed in the United States District Court for the Middle District of Tennessee against BioMimetic Therapeutics, Inc. and certain of its officers and directors, alleging BioMimetic was unduly positive in its public statements about the prospects for FDA approval of Augment® Bone Graft. We acquired BioMimetic in March 2013. In January 2013, the Court granted BioMimetic's, and the other named defendants', motion to dismiss the lawsuit, known as Paula Kuyat, et. al. versus BioMimetic Therapeutics, Inc. et. al., without leave to amend the complaint. The plaintiffs filed a Motion to Alter Judgment or Amend Order and Judgment of Dismissal with Prejudice, seeking reconsideration of the Court's dismissal decision. This motion was denied. Subsequently, the plaintiffs appealed the Court’s dismissal of the case to the United

20

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


States Court of Appeals for the Sixth Circuit. The Court of Appeals heard oral argument on December 4, 2013. During the quarter ended March 31, 2014, the dismissal of the BioMimetic securities class action was upheld by the Sixth Circuit.
Other
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.
13. Segment Information
During the first quarter of 2014, our management, including our chief executive officer, who is our chief operating decision maker, began managing our operations as three operating business segments: U.S., International and BioMimetic, based on management's change to the way it monitors performance, aligns strategies, and allocates resources results in a change in our reportable segments. We determined that each of these operating segments represented a reportable segment.
Our U.S. and International segments represent the commercial, administrative and research & development activities dedicated to the respective geographies. The BioMimetic segment represents the administrative and research & development activities of the acquired BioMimetic business (international sales and associated expenses for Augment® products are included within the International segment). The Corporate category shown in the table below primarily reflects general and administrative expenses not specifically associated with the U.S., International or BioMimetic segments. These non-allocated corporate expenses
relate to global administrative expenses that support all segments, including salaries and benefits of executive officers and expenses such as: information technology administration and support; corporate headquarters; legal, compliance, and corporate finance functions; insurance; and all stock based compensation.
Management measures segment profitability using an internal operating performance measure that excludes the impact of inventory step-up amortization, charges associated with distributor conversions and related non-competes, and due diligence, transactions and transition costs associated with acquisitions.
Selected financial information related to our segments is presented below for the three months ended March 31, 2014 and 2013 (in thousands):
 
Three Months Ended March 31, 2014
 
U.S.
International
BioMimetic
Corporate
Total
Sales
$
48,951

$
22,111

$

$

$
71,062

Depreciation expense
2,297

641

108

1,195

4,241

Amortization expense
1,096

577

77


1,750

Segment operating income (loss)
$
5,679

$
803

$
(3,391
)
$
(17,589
)
$
(14,498
)
Other:
 
 
 
 
 
Inventory step-up amortization
 
 
 
 
(604
)
Distributor conversion and non-compete charges
 
 
 
 
(542
)
Acquisition due diligence, transaction and transition expenses
 
 
 
 
(7,402
)
Operating loss
 
 
 
 
(23,046
)
Interest expense, net
 
 
 
 
4,136

Other (income) expense, net
 
 
 
 
15,286

Loss before income taxes
 
 
 
 
$
(42,468
)
Capital expenditures
$
5,200

$
733

$
2

$
1,901

$
7,836



21

WRIGHT MEDICAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)


 
Three Months Ended March 31, 2013
 
U.S.
International
BioMimetic
Corporate
Total
Sales
$
42,761

$
13,532

$

$

$
56,293

Depreciation expense
2,145

632

39

630

3,446

Amortization expense
615

75

86


776

Segment operating income (loss)
$
6,987

$
2,192

$
(1,311
)
$
(12,302
)
$
(4,434
)
Other:
 
 
 
 
 
Inventory step-up amortization
 
 
 
 
(108
)
Distributor conversion and non-compete charges
 
 
 
 
(1,186
)
Acquisition due diligence, transaction and transition expenses
 
 
 
 
(7,498
)
Operating loss
 
 
 
 
(13,226
)
Interest expense, net
 
 
 
 
3,945

Other (income) expense, net
 
 
 
 
(5,849
)
Loss before income taxes
 
 
 
 
$
(11,322
)
Capital expenditures
$
1,116

$
43

$

$
1,665

$
2,824

Total capital expenditures for the three months ended March 31, 2013, does not include $0.9 million related to discontinued operations and the OrthoRecon divestiture.
Assets in the U.S., International and BioMimetic segments are those assets used exclusively in the operations of each business segment or allocated when used jointly. Assets in the Corporate category are principally cash and cash equivalents, marketable securities, property, plant and equipment, assets associated with OrthoRecon insurance receivables, and assets associated with income taxes. Total assets by business segment as of March 31, 2014 are as follows (in thousands):
 
March 31, 2014
 
U.S.
International
BioMimetic
Corporate
Total
Total assets
$
247,652

$
79,572

$
12,163

$
684,462

$
1,023,849


Our principal geographic regions consist of the United States, Europe (which includes the Middle East and Africa), and Other (which principally represents Asia, Australia, Canada, and Latin America). The following table presents net sales by geographic area for the three months ended March 31, 2014 and 2013 (in thousands):
 
Three Months Ended
Geographic
March 31, 2014
 
March 31, 2013
 
% change
United States
$
48,951

 
$
42,761

 
14.5
%
Europe
13,742

 
7,259

 
89.3
%
Other
8,369

 
6,273

 
33.4
%
Total net sales
$
71,062

 
$
56,293

 
26.2
%



22


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

General
The following management’s discussion and analysis of financial condition and results of operations describes the principal factors affecting the results of our operations, financial condition, and changes in financial condition for the three month period ended March 31, 2014. This discussion should be read in conjunction with the accompanying unaudited financial statements, our Annual Report on Form 10-K for the year ended December 31, 2013, which includes additional information about our critical accounting policies and practices and risk factors, and Note 1 of Part I of this Quarterly Report and Part II, Item 1A of this Quarterly Report.
Executive Overview
Company Description. We are a global orthopaedic company that provides solutions that enable clinicians to alleviate pain and restore their patients' lifestyles. We are a recognized leader of surgical solutions for the foot and ankle market and market our products in over 60 countries worldwide. 
Our business includes products that are used primarily in foot and ankle repair, upper extremity products, and biologics products, which are used to replace damaged or diseased bone, to stimulate bone growth and to provide other biological solutions for surgeons and their patients. 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. Our extensive foot and ankle product portfolio, our approximately 200 specialized foot and ankle sales representatives, and our increasing level of training of foot and ankle surgeons has resulted in us 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 Memphis, Tennessee, where we conduct research and development, sales and marketing administration and administrative activities. Our manufacturing and warehousing activities are located in Arlington, Tennessee. Our products are sold primarily 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. We promote our products in approximately 60 countries with principal markets in the U.S., Europe, the Middle East, Africa, Asia, Canada, Australia and Latin America.
Principal Products. We specialize in foot & ankle and other 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.
Significant Quarterly Business Developments. On January 9, 2014, we completed the sale of our hip/knee (OrthoRecon) business to MicroPort Scientific Corporation (MicroPort). The financial results of our OrthoRecon business have been reflected within discontinued operations for all periods presented and, unless otherwise noted, the discussion below is on a continuing operations basis. With the divestiture of our OrthoRecon business, our transition to a high-growth global Extremities and Biologics company is complete.
On January 30, 2014, we completed our acquisition of Solana Surgical, LLC (Solana), and on February 5, 2014, we completed our acquisition of OrthoPro, L.L.C. (OrthoPro), both privately held, high growth extremities companies. These acquisitions add complementary extremity product portfolios to further accelerate growth opportunities in our U.S. business.
Under the terms of the agreement with Solana, we acquired 100% of Solana's outstanding equity for total consideration, net of cash acquired, of $90 million, consisting of approximately $48.0 million in cash, subject to certain adjustments set forth in the definitive agreement, and approximately $41.4 million of Wright common stock. Under the terms of the agreement with OrthoPro, we acquired 100% of OrthoPro's outstanding equity for a total purchase price of up to $36.5 million in cash, consisting of $33.0 million paid at closing (net of cash acquired), subject to certain adjustments set forth in the definitive agreement, and up to an additional $3.5 million in cash contingent upon achievement of certain revenue-based milestones.
On March 10, 2014, we reached an agreement with the Office of Device Evaluation (ODE) of the U.S. Food and Drug Administration (FDA) under which ODE will accept a further amendment to the Pre-Market Approval application (PMA) for Augment® Bone Graft in lieu of proceeding with the Dispute Resolution Panel (DRP) that was scheduled for the week of May 19, 2014. The PMA amendment will consist of analyses of pre-existing radiographic films of clinical study patients at pre-operative and post-operative time points. ODE has committed to an expeditious review of the PMA amendment and agreed to issue a determination on whether the PMA is approvable no later than 180 days after submission of the PMA amendment. We note that this PMA amendment does not guarantee the approval of Augment® Bone Graft, and that we intend to renew the DRP process if the PMA amendment fails to result in a reversal of ODE’s previous not approvable determination.

23


Net sales increased 26% in the quarter ended March 31, 2014 to $71.1 million, compared to net sales of $56.3 million in the quarter ended March 31, 2013, driven primarily by a 31% increase in global foot and ankle sales.
Our U.S. sales increased 14% in first quarter of 2014, as a 19% increase in foot and ankle sales and a 7% increase in biologics sales were partially offset by an 11% decrease in upper extremity sales. Acquired products from Solana and OrthoPro contributed 11 percentage points of the foot and ankle sales growth.
Our international sales increased 63% to $22.1 million in the first quarter of 2014, compared to $13.5 million in the first quarter of 2013, primarily due to the Biotech acquisition in the fourth quarter of 2013. Acquired products from Biotech contributed 34 percentage points of the international growth. The remaining growth was driven primarily by a 17% increase in Europe, a 55% increase in Asia as the result of the addition of a new distribution partner in China during the quarter ended June 30, 2013, and a 27% increase in Australia due to increased sales of Augment® Bone Graft acquired in the first quarter of 2013.
In the first quarter of 2014, we recorded a net loss of $30.3 million, compared to a net loss of $4.9 million for the first quarter of 2013. Items unfavorably impacting the net loss in the first quarter of 2014 included:
$14.3 million unrealized loss related to mark-to-market adjustments on the Contingent Value Rights (CVRs) issued in connection with the acquisition of BioMimetic;
a decrease of $7.8 million related to the gain on previously held investments in BioMimetic that was realized in 2013 upon the closing of our acquisition of BioMimetic;
$2.2 million of transition costs associated with the sale of our OrthoRecon business;
decreased profitability, primarily driven by expense dis-synergies following the sale of our OrthoRecon business and operating losses associated with the acquired BioMimetic business;
an unfavorable effective tax rate due to the valuation allowance on our U.S. net deferred tax assets, resulting in the inability to recognize a tax benefit for pre-tax losses in the U.S., except to the extent to which we recognize a gain in discontinued operations.
These unfavorable impacts were partially offset by a $2.3 million decrease in due diligence, transaction and transition costs associated with acquisition activities, and a $1.0 million decrease in net unrealized losses associated with the mark-to-market adjustments on our derivative assets and liabilities.
Following the sale of the OrthoRecon business, we began segregating our reporting units into three reportable segments, U.S., International and BioMimetic. See Note 13 to our condensed consolidated financial statements for additional information.
Opportunities and Challenges. Following the sale of the OrthoRecon business, we are well positioned and committed to accelerating growth in our foot and ankle business and increasing U.S. foot and ankle sales productivity. We have made changes to attempt to realize these opportunities, including aggressively converting a portion of our U.S. independent distributor foot and ankle territories to direct employee sales representation, and substantially increasing our investment in foot and ankle medical education to drive market adoption of new products and technologies.
Business continuity and a seamless customer experience are top priorities, and we are highly focused on ensuring that no business momentum is lost during the transition period. As such, we will have inefficiencies immediately post the transaction but will have an excellent opportunity to improve efficiency and leverage fixed costs in the business going forward. Additionally, there will be expense dis-synergies as a result of the transaction, and we do expect some short-term revenue dis-synergies as we work through the separation of some of the remaining full-line distribution both in the U.S. and outside the U.S.
Following the sale of the OrthoRecon business, we are a high growth business. However, we do anticipate having operating losses until we are able to grow our revenue to a sufficient level to support our current cost structure.
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 FDA. Failure to comply with regulatory requirements could have a material adverse effect on our business.

Results of Operations
On January 9, 2014, we completed the sale of the OrthoRecon business to MicroPort. The financial results of the OrthoRecon business, along with on-going expenses associated with that business, have been reflected within discontinued operations for all periods presented.

24


Comparison of three months ended March 31, 2014 to three months ended March 31, 2013
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:
 
Three Months Ended March 31,
 
2014
 
2013
 
Amount
 
% of Sales
 
Amount
 
% of Sales
Net sales
$
71,062

 
100.0
%
 
$
56,293

 
100.0
%
Cost of sales 1
17,417

 
24.5
%
 
13,697

 
24.3
%
Gross profit
53,645

 
75.5
%
 
42,596

 
75.7
%
Operating expenses:
 
 
 

 
 
 
 
Selling, general and administrative 1
68,648

 
96.6
%
 
50,709

 
90.1
%
Research and development 1
5,856

 
8.2
%
 
3,507

 
6.2
%
Amortization of intangible assets
2,187

 
3.1
%
 
1,606

 
2.9
%
Total operating expenses
76,691

 
107.9
%
 
55,822

 
99.2
%
Operating loss
(23,046
)
 
(32.4
%)
 
(13,226
)
 
(23.5
%)
Interest expense, net
4,136

 
5.8
%
 
3,945

 
7.0
%
Other (income) expense, net
15,286

 
21.5
%
 
(5,849
)
 
(10.4
%)
Loss from continuing operations before income taxes
(42,468
)
 
(59.8
%)
 
(11,322
)
 
(20.1
%)
Benefit from income taxes
(12,170
)
 
(17.1
%)
 
(6,404
)
 
(11.4
%)
Net loss from continuing operations
(30,298
)
 
(42.6
%)
 
(4,918
)
 
(8.7
%)
(Loss) income from discontinued operations, net of tax 1
(122
)
 
 
 
13,353

 
 
Net (loss) income
$
(30,420
)
 
 
 
$
8,435

 
 
__________________________
(1) 
These line items include the following amounts of non-cash, stock-based compensation expense for the periods indicated:
 
Three Months Ended March 31,
 
2014
 
% of Sales
 
2013
 
% of Sales
Cost of sales
$
111

 
0.2
%
 
$
147

 
0.3
%
Selling, general and administrative
2,004

 
2.8
%
 
3,645

 
6.5
%
Research and development
205

 
0.3
%
 
121

 
0.2
%
(Loss) income from discontinued operations, net of tax

 
n/a

 
705

 
n/a


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:
 
Three Months Ended
 
March 31, 2014
 
March 31, 2013
 
%
change
U.S.
 
 
 
 
 
Foot and Ankle
33,127

 
27,763

 
19.3
%
Upper Extremity
3,653

 
4,114

 
(11.2
%)
Biologics
11,143

 
10,453

 
6.6
%
Other
1,028

 
431

 
138.5
%
Total U.S.
$
48,951

 
$
42,761

 
14.5
%
 
 
 
 
 
 
International
 
 
 
 
 
Foot and Ankle
12,874

 
7,314

 
76.0
%
Upper Extremity
2,825

 
1,948

 
45.0
%
Biologics
4,497

 
3,204

 
40.4
%
Other
1,915

 
1,066

 
79.6
%
Total International
$
22,111

 
$
13,532

 
63.4
%
 
 
 
 
 
 
Total Sales
$
71,062

 
$
56,293

 
26.2
%
 
 
 
 
 
 


25


Net Sales
U.S. Segment. Net sales in our U.S. segment totaled $49.0 million in the first quarter of 2014, as compared to $42.8 million in the first quarter of 2013, a 14% increase.
Our U.S. foot and ankle net sales increased to $33.1 million in the first quarter of 2014, representing growth of 19% over the first quarter of 2013. Sales of products acquired from Solana and OrthoPro contributed 11 percentage points of this growth (i.e., growth without acquired products was 8%). The remaining increase was primarily driven by continued growth of our Total Ankle Replacement products.
Our U.S. biologics sales totaled $11.1 million in the first quarter of 2014, representing a 7% increase from the first quarter of 2013, driven primarily by an increase in the sales of our PRO-DENSE® and PRO-STIM® line of products.
International Segment. Net sales in our International segment totaled $22.1 million in the first quarter of 2014, as compared to $13.5 million in the first quarter of 2013, a 63% increase. Sales of products acquired from Biotech International contributed 33 percentage points of this growth.
Our international foot and ankle sales increased 76% to $12.9 million in the first quarter of 2014. Sales of foot and ankle products acquired from Biotech International contributed 35 percentage points of this growth (i.e., growth without these acquired products was 41%). The remaining growth was driven primarily by growth in Asia as the result of the addition of a new distribution partner in China in the second quarter of 2013, and continued success from the WG Healthcare acquisition in January 2013, and increases in other geographic regions as a result of our focus on international market expansion focus.
Our international biologics sales increased 40% as the result of a 47% increase of sales in Australia, primarily related to sales of Augment® Bone Graft acquired from the BioMimetic acquisition in the first quarter of 2013, and a 55% increase in Asia as the result of the addition of a new distribution partner in China in the second quarter of 2013.
Cost of Sales
Our cost of sales as a percentage of net sales increased to 24.5% in the first quarter of 2014, as compared to 24.3% in the first quarter of 2013. The increase as a percentage of net sales is due to increased inventory step-up amortization associated with recent acquisitions, mostly offset by lower provisions for excess and obsolete inventory. 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, cost of raw materials, and currency exchange rates.
Selling, General and Administrative
Our selling, general and administrative expenses as a percentage of net sales totaled 96.6% in the first quarter of 2014, compared to 90.1% in the first quarter of 2013. Selling, general and administrative expense for the first quarter of 2014 included $2.2 million of transition costs associated with the sale of the OrthoRecon business (3.2% of net sales), and $5.2 million of due diligence, transition and transaction costs related to our recent acquisitions (7.3% of net sales). Selling, general and administrative expense for the first quarter of 2013 included $7.5 million of due diligence, transition and transaction costs associated with our acquisition of BioMimetic (13.3% of net sales), and $0.4 million of cost related to distributor transition agreements (0.6% of net sales). The remaining selling, general and administrative expenses increase as a percentage of sales is primarily driven by a $1.5 million increase to expenses associated with the ongoing operations of BioMimetic acquired late in the first quarter of 2013, including business, legal and other expenses associated with our appeal of the not approvable letter from the FDA (3.1% of net sales), continued investment in international growth opportunities and dis-synergies as a result of the sale of the OrthoRecon business in certain corporate and international expenses. These dis-synergies include expenses associated with our information technology support, a new corporate headquarters, and international employees and facilities. Additionally, we are incurring short-term expense dis-synergies associated with the acquired Solana and OrthoPro businesses until they are integrated in late 2014.
Research and Development
Our investment in research and development activities represented approximately 8.2% of net sales in the first quarter of 2014, as compared to 6.2% of net sales in the first quarter of 2013. The increase in research and development costs as a percentage of net sales is primarily attributable to increased spending associated with the acquired BioMimetic business and increased product development spending within our U.S. segment. In addition, our research and development expenses have increased as a percent of sales due to dis-synergies in certain shared functions as a result of the sale of the OrthoRecon business.
Amortization of Intangible Assets
Charges associated with the amortization of intangible assets were $2.2 million in the first quarter of 2014 compared to $1.6 million in the first quarter of 2013. The increase is due to amortization of intangible assets acquired in our recent BioMimetic, Biotech, Solana and OrthoPro acquisitions over the past year.

26


Based on the intangible assets held as of March 31, 2014, we expect to recognize amortization expense of approximately $10.3 million for the full year of 2014, $8.0 million in 2015, $6.5 million in 2016, $6.3 million in 2017, and $5.6 million in 2018.
Interest Expense, Net
Interest expense, net, consists of interest expense of $4.2 million during the first quarter of 2014 and $4.1 million during the first quarter of 2013, offset by interest income of $0.1 million during the first quarter of 2014 and 2013. Our interest expense relates primarily to non-cash interest expense associated with the amortization of the discount on our 2017 Notes of $2.3 million and $2.1 million in 2014 and 2013, respectively, as well as interest expense on our 2017 Notes totaling $1.5 million in both 2014 and 2013. Our interest income is generated by our invested cash balances and investments in marketable securities. The amounts of interest income we expect to realize in 2014 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.
Other (Income) Expense, Net
Other (income) expense, net was $15.3 million of expense in the first quarter of 2014, compared to $5.8 million of income in the first quarter of 2013. For the first quarter of 2014, other (income) expense, net includes an unrealized loss of $14.3 million for the mark-to-market adjustment on CVRs issued in connection with the acquisition of BioMimetic, and a net unrealized loss of $1.0 million for mark-to-market adjustments on our derivative assets and liabilities. For the first quarter of 2013, other (income) expense, net includes a $7.8 million gain on the previously held investment in BioMimetic, and a $2.0 million unrealized loss on mark-to-market adjustments on our derivative assets and liabilities.
Benefit from Income Taxes
We recorded an income tax benefit of $12.2 million in the first quarter of 2014, compared to a tax benefit of $6.4 million in the first quarter of 2013. During the first quarter of 2014, our effective tax rate was approximately 28.7% as compared to 56.6% in the first quarter of 2013. The decrease in the effective tax benefit rate is primarily related to the valuation allowance on our U.S. net deferred tax assets, resulting in the inability to recognize a tax benefit for pre-tax losses in the U.S., except to the extent to which we recognize a gain in discontinued operations.
(Loss) Income from Discontinued Operations, Net of Tax
(Loss) income from discontinued operations, net of tax, consists of the operations of the OrthoRecon business that we have sold to MicroPort. For 2014, net income includes operations from January 1 through January 9, 2014, which was the closing date of the transaction, costs associated with legal defense and changes to any contingent liabilities associated with the OrthoRecon business, as well as the after tax impact of the $24.3 million gain on the sale of the OrthoRecon business. The 2014 effective tax rate of 100.8% within results of discontinued operations reflects the sale of non-deductible goodwill of $25.8 million associated with the OrthoRecon segment.
For 2013, income from discontinued operations includes a full quarter of activity of the OrthoRecon business.
Reportable Segments
The following table sets forth, for the periods indicated, sales, gross profit and operating income of our reportable segments expressed as dollar amounts (in thousands) and as a percentage of net sales:
 
U.S.
 
International
 
BioMimetic
 
Three Months Ended March 31,
 
2014
2013
 
2014
2013
 
2014
2013
Net Sales
$
48,951

$
42,761

 
$
22,111

$
13,532

 
$

$

Gross Profit
39,853

33,865

 
14,507

8,987

 


Gross Profit as a percent of net sales
81.4
%
79.2
%
 
65.6
%
66.4
%
 
N/A

N/A

Operating Income (Expense)
$
5,679

$
6,987

 
$
803

$
2,192

 
$
(3,391
)
$
(1,311
)
Operating Income as a percent of net sales
11.6
%
16.3
%
 
3.6
%
16.2
%
 
N/A

N/A

U.S. Segment - Gross profit as a percent of net sales increased due to lower provisions for excess and obsolete inventory. Operating income decreased due to investments in sales and marketing and distribution initiatives, as well as short-term expense dis-synergies and intangible asset amortization associated with the acquired Solana and OrthoPro businesses, mostly offset by increased gross profit from the increase in revenue.
International Segment - The decrease in gross profit as a percent of net sales is due to unfavorable geographic and product mix. The decrease in operating income is due to dis-synergies for the replacement of certain employee-related and facility expenses as a result of the sale of the OrthoRecon business.

27


BioMimetic Segment - The increase in operating loss for the quarter is the result of a full quarter of operations in 2014 and expenses associated with our appeal of the not approvable letter received from the FDA, whereas there was only one month of operations in the first quarter of 2013 based on the timing of the acquisition of the business.

Liquidity and Capital Resources
The following table sets forth, for the periods indicated, certain liquidity measures (in thousands):
 
As of March 31, 2014
 
As of December 31, 2013
Cash and cash equivalents
$
343,852

 
$
168,534

Short-term marketable securities
9,247

 
6,898

Long-term marketable securities
3,499

 
7,650

Working capital
431,449

 
385,890

We invest in long-term marketable securities with original maturity dates ranging from 17 to 36 months, consisting of investments in government, agency, and corporate bonds. As of March 31, 2014, the weighted average original maturity for these investments was 17 months.
Operating Activities. Cash used in operating activities was $27.2 million for the first three months of 2014 as compared to cash used by operating activities of $5.2 million for the first three months of 2013. The decrease is driven by lower profitability and changes in working capital.
Investing Activities. Our capital expenditures totaled approximately $7.8 million and $3.7 million in the first three months of 2014 and 2013, respectively. The increase is primarily related to spending related to the move of our corporate headquarters and expansion of our manufacturing and distribution facility. Our industry is capital intensive, particularly as it relates to surgical instrumentation. Historically, our capital expenditures have consisted of purchased surgical instruments, manufacturing equipment, research and testing equipment, computer systems, and office furniture and equipment. We expect to incur capital expenditures of approximately $50 million in 2014.
In connection with our 2014 acquisitions of Solana and OrthoPro, we paid $80.5 million cash, net of cash acquired, for these businesses. Refer to Note 2 of our condensed consolidated financial statements for additional information regarding these acquisitions. In connection with our 2013 acquisitions of BioMimetic and WG Healthcare, we paid $40.4 million cash, net of cash acquired, for these businesses.
Financing Activities. During the first three months of 2014, cash provided by financing activities totaled $10.7 million compared to the first three months of 2013 when cash used in financing activities totaled $0.9 million. The change is primarily attributable to cash received for stock option exercises in the first quarter of 2014.
As of March 31, 2014, we had less than 15% of our consolidated 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. We do not intend to repatriate these funds.
Discontinued Operations. Cash flows from discontinued operations are combined with cash flows from continuing operations in the Condensed Consolidated Statement of Cash Flows. During the first three months of 2014, cash inflows from discontinued operations was approximately $270 million, driven by the cash received from the sale of the OrthoRecon business, compared to cash used of approximately $1 million in the first three months of 2013. We do not expect that the absence of cash flows from discontinued operations will have an impact on our ability to meet contractual cash obligations, fund our working capital requirements, operations, and anticipated capital expenditures.

In process research and development. In connection with our BioMimetic acquisition, we acquired in-process research and development (IPRD) technology related to projects that had not yet reached technological feasibility as of the acquisition date, which included Augment® Bone Graft, which was undergoing the FDA approval process, and Augment® Injectable Bone Graft. The acquisition date fair values of the IPRD technology was $61.2 million for Augment® Bone Graft and $27.1 million for Augment® Injectable Bone Graft. The fair value of the IPRD technology was $4.3 million as of March 31, 2014, which reflects the impairment charges recognized in 2013 after receipt of the not approvable letter from the FDA in response to our PMA application for Augment® Bone Graft for use as an alternative to autograft in hindfoot and ankle fusion procedures. The fair value of the research and development projects was determined using the income approach, which discounts expected future cash flows from the acquired in-process technology to present value. The discount rate applied to the expected future cash flows included a premium to the base required rate of return, in consideration of the risks associated with the FDA approval process.

28


On March 10, 2014, we reached an agreement with the Office of Device Evaluation (ODE) of the U.S. Food and Drug Administration (FDA) under which ODE will accept a further amendment to the Pre-Market Approval application (PMA) for Augment® Bone Graft in lieu of proceeding with the Dispute Resolution Panel (DRP) that was scheduled for the week of May 19, 2014. The PMA amendment will consist of analyses of pre-existing radiographic films of clinical study patients at pre-operative and post-operative time points. ODE has committed to an expeditious review of the PMA amendment and agreed to issue a determination on whether the PMA is approvable no later than 180 days after submission of the PMA amendment. We note that this PMA amendment does not guarantee the approval of Augment® Bone Graft, and that we intend to renew the DRP process if the PMA amendment fails to result in a reversal of ODE’s previous not approvable determination.

The IPRD projects acquired are as follows:
Augment® Bone Graft (Augment) is based on our platform regenerative technology, which combines an engineered version of recombinant human platelet-derived growth factor BB (rhPDGF-BB), one of the principal wound healing and tissue repair stimulators in the body, with tissue specific matrices, when appropriate. This product is intended to offer physicians advanced biological solutions to actively stimulate the body’s natural tissue regenerative process. Augment is targeted to be used in the open (surgical) treatment of fusions. Additionally, Augment may be useful in the future to be used in open fractures. We have evaluated Augment in several open clinical applications, including foot and ankle fusions and distal radius fractures. We believe we have demonstrated that our technology is safe and effective in stimulating bone regeneration with the Canadian regulatory approval of Augment in 2009 and the Australian and New Zealand regulatory clearance of Augment in 2011. A PMA application for the use of Augment in the U.S. as an alternative to autograft in hindfoot and ankle fusion procedures was submitted to the FDA prior to this acquisition. We’ve incurred expenses of approximately $8.2 million for Augment since the date of acquisition and approximately $2.8 million in the three months ended March 31, 2014. Future costs related to Augment depends on the ultimate decision by the FDA on the PMA.

Augment® Injectable Bone Graft (Augment Injectable) combines rhPDGF-BB with an injectable bone matrix, and is targeted to be used in either open (surgical) treatment of fusions and fractures or closed (non-surgical) or minimally invasive treatment of fractures. Augment Injectable can be injected into a fusion or fracture site during an open surgical procedure, or it can be injected through the skin into a fracture site, in either case locally delivering rhPDGF-BB to promote fusion or fracture repair. Our initial clinical development program for Augment Injectable has focused on securing regulatory approval for open indications in the United States and in several markets outside the U.S. Recently, we have focused our efforts on securing FDA approval of Augment. The amount of time and cost to complete the Augment Injectable project depends upon the nature of the approval we ultimately receive for Augment, but we currently estimate it could take one to three years. We’ve incurred expenses of approximately $1.9 million for Augment Injectable since the date of acquisition and approximately $0.1 million in the three months ended March 31, 2014. Future costs related to Augment depends on the ultimate decision by the FDA on the PMA.

Other Liquidity Information
We have funded our cash needs since 2000 through various equity and debt issuances and through cash flow from operations. Although it is difficult for us to predict our future liquidity requirements, we believe that our current cash balance of approximately $343.9 million and our marketable securities balances totaling $12.7 million will be sufficient for the foreseeable future to fund our working capital requirements, operations, and anticipated capital expenditures in 2014 of approximately $50 million, and to meet our contractual cash obligations in 2014. Furthermore, we intend to use our cash and marketable securities balance to fund transition costs of $25 million to $35 million and the remainder to fund growth opportunities for our Extremities and Biologics business and pay certain retained liabilities of the OrthoRecon business.
Critical Accounting Policies and Estimates
Information on judgments related to our most critical accounting policies and estimates is discussed in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2013. 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. Actual results may differ from these judgments under different assumptions or conditions. Different, reasonable estimates could have been used for 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. All of our significant accounting policies are more fully described in Note 2 to our consolidated financial statements set forth in our Annual Report on Form 10-K for the year ended December 31, 2013.

29


ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
There have been no material changes from the information reported under Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2013.


30


ITEM 4. CONTROLS AND PROCEDURES.
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 March 31, 2014 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 March 31, 2014.
Changes in Internal Control Over Financial Reporting
During the three month period ended March 31, 2014, we completed the sale of the OrthoRecon business to MicroPort. In connection with this transaction, many long term employees with valuable institutional knowledge were transitioned to MicroPort, key systems were replicated across both companies, and our financial controls environment was physically moved to a new location. Accordingly, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of these changes in internal control over financial reporting. Based on this evaluation, our management concluded that these changes did not diminish the design of our internal control over financial reporting.
Other than the transitions following this divestiture, during the three months ended March 31, 2014, there were no 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.



31


PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.
From time to time, we are subject to lawsuits and claims that arise out of our operations in the normal course of business. We are the plaintiff or defendant in various litigation matters in the ordinary course of business, some of which involve claims for damages that are substantial in amount.
Governmental Inquiries
On September 29, 2010, we 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). The CIA was filed as Exhibit 10.2 to our current report on Form 8-K filed on September 30, 2010. The CIA will expire on September 29, 2015.
The CIA imposes on us certain obligations 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, potential prosecution, civil and criminal fines or penalties, as well as additional litigation cost and expense.
Both we and MicroPort, which completed the purchase of our OrthoRecon business in January 2014, will continue to be subject to the CIA.
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 CIA. In addition, the matters which gave rise to the CIA could increase our exposure to lawsuits by potential whistleblowers, including under the federal false claims acts, based on new theories or allegations arising from these matters.
On August 3, 2012, we received a subpoena from the U.S. Attorney's Office for the Western District of Tennessee requesting records and documentation relating to our PROFEMUR® series of hip replacement devices. The subpoena covers the period from January 1, 2000 to August 2, 2012. We continue to respond to the subpoena.
Patent Litigation
In 2011, Howmedica Osteonics Corp. (Howmedica) and Stryker Ireland, Ltd. (collectively, 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 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. On July 9, 2013, the district court issued a claim construction ruling. Under the court's claim construction ruling, we do not believe these hip products infringe the asserted patents. In filings with the court, Stryker has conceded that under the court’s claim construction rulings it can no longer pursue its infringement claims. Stryker has asked the court to dismiss the case so it may pursue an appeal.
In 2012, Bonutti Skeletal Innovations, LLC (Bonutti) filed a patent infringement lawsuit against us in the United States Court for the District of Delaware. In January 2014, we filed a request with the U.S. Patent and Trademark Office for Inter Partes Review (IPR) of the Bonutti patents. On April 7, 2014, the Court stayed the case pending outcome of the IPR. Bonutti originally alleged that the Link Sled Prosthesis infringes U.S. Patent 6,702,821. The Link Sled Prosthesis is a product we distributed under a distribution agreement with LinkBio Corp, which expired on December 31, 2013. In January 2013, Bonutti amended its complaint, alleging that the ADVANCE® knee system, including ODYSSEY® instrumentation, infringes U.S. Patent 8,133,229, and that the ADVANCE® knee system, including ODYSSEY® instrumentation and PROPHECY® guides, infringes U.S. Patent 7,806,896, which was issued on October 5, 2010. All of the claims of the asserted patents are directed to surgical methods for minimally invasive surgery.
In June 2013, Orthophoenix filed a patent lawsuit against us in the United States District Court for the District of Delaware alleging that surgical methods using the X-REAM® product infringe two patents.
In June 2013, Anglefix filed suit in the United States District Court for the Western District of Tennessee, alleging that our ORTHOLOC® products infringe Anglefix’s asserted patent. On April 14, 2014 we filed a request for IPR with the U.S. Patent and Trademark Office.
In September 2013, ConforMIS, Inc. filed suit against us in the United States District Court for the District of Massachusetts, alleging that our PROPHECY® knee and ankle systems infringe four ConforMIS’ patents. On February 19, 2014, ConforMIS filed an amended complaint asserting four additional patents against us relating to alleged infringement by our PROPHECY® knee and ankle systems and naming MicroPort Orthopedics as an additional defendant.

32


Subject to the provisions of the asset purchase agreement with MicroPort for the sale of our OrthoRecon business, we will continue to be responsible for defense of pre-existing patent infringement cases relating to our OrthoRecon business, and for resulting liabilities, if any.
Product Liability
WMT has been named as a defendant, in some cases with multiple other defendants, in lawsuits in which it is alleged that as yet unspecified defects in the design, manufacture or labeling of certain metal-on-metal hip replacement products rendered the products defective. The lawsuits generally employ similar allegations that use of the products resulted in excessive metal ions and particulate in the patients into whom the devices were implanted, in most cases resulting in revision surgery. We anticipate that additional lawsuits relating to metal on metal hip replacement products may be brought. 
Because of the similar nature of the allegations made by several plaintiffs whose cases were pending in federal courts, upon motion of one plaintiff, Danny L. James, Sr., the United States Judicial Panel on Multidistrict Litigation in February 2012 transferred certain actions pending in the federal court system related to metal on metal hip replacement products to the United States District Court for the Northern District of Georgia, for consolidated pre-trial management of the cases before a single United States District Court Judge (the MDL). The consolidated matter is known as In re: Wright Medical Technology, Inc. Conserve Hip Implant Products Liability Litigation.   
Certain plaintiffs have elected to file their lawsuits in state courts in California. In doing so, most of those plaintiffs have named a surgeon involved in the design of the allegedly defective products as a defendant in the actions, along with his personal corporation. Pursuant to contractual obligations, Wright Medical has agreed to indemnify and defend the surgeon in those actions. Similar to the MDL proceeding in federal court, because the lawsuits generally employ similar allegations, certain of those pending lawsuits in California were consolidated for pretrial handling on May 14, 2012 pursuant to procedures of California state Judicial Counsel Coordinated Proceedings. The consolidated matter is known as In re: Wright Hip Systems Cases, Judicial Counsel Coordination Proceeding No. 4710.
There are other individual lawsuits related to metal on metal hip products pending in various state courts.
Additionally, as of April 24, 2014, we are a defendant in 38 lawsuits in various state and federal courts involving claims for damages for personal injury associated with fractures of our PROFEMUR® long titanium modular neck product.
Employment Litigation
In 2012, two former employees, Frank Bono and Alicia Napoli, each filed separate lawsuits against WMT in the Chancery Court of Shelby County, Tennessee, which asserted 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. Bono and Ms. Napoli each claimed that he or she was entitled to attorney fees in addition to other unspecified damages. On October 23, 2013, Ms. Napoli moved to voluntary dismiss her lawsuit, without prejudice. On April 4, 2014, Ms. Napoli refiled her case in the United States District Court for the Eastern District of Missouri.
Securities Litigation
On July 6, 2011, a purported federal securities class action lawsuit was filed in the United States District Court for the Middle District of Tennessee against BioMimetic Therapeutics, Inc. and certain of its officers and directors, alleging BioMimetic was unduly positive in its public statements about the prospects for FDA approval of Augment® Bone Graft. We acquired BioMimetic in March 2013. In January 2013, the Court granted BioMimetic's, and the other named defendants', motion to dismiss the lawsuit, known as Paula Kuyat, et. al. versus BioMimetic Therapeutics, Inc. et. al., without leave to amend the complaint. The plaintiffs filed a Motion to Alter Judgment or Amend Order and Judgment of Dismissal with Prejudice, seeking reconsideration of the Court's dismissal decision. This motion was denied. Subsequently, the plaintiffs appealed the Court’s dismissal of the case to the United States Court of Appeals for the Sixth Circuit. The Court of Appeals heard oral argument on December 4, 2013. During quarter ended March 31, 2014, the dismissal of the BioMimetic securities class action was upheld by the Sixth Circuit Court.
ITEM 1A. RISK FACTORS.

Not applicable.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.


33


ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. MINE SAFETY DISCLOSURES.

Not applicable.

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS.

(a)
Exhibits.
The following exhibits are filed as a part of this quarterly report on Form 10-Q or are incorporated herein by reference:
Exhibit
No.
 
Description
3.1
 
Fourth Amended and Restated Certificate of Incorporation of Wright Medical Group, Inc., (1) as amended by Certificate of Amendment of Fourth Amended and Restated Certificate of Incorporation of Wright Medical Group, Inc. (2) and Certificate of Amendment for Fourth Amended and Restated Certificate of Incorporation of Wright Medical Group, Inc. (3)
 
 
 
3.2
 
Third Amended and Restated By-laws of Wright Medical Group, Inc. (4)
 
 
 
4.1
 
Form of Common Stock certificate. (1)
 
 
 
4.2
 
Indenture, dated as of November 26, 2007, between Wright Medical Group, Inc. and The Bank of New York as trustee (including form of 2.625% Convertible Senior Notes due 2014). (5)
 
 
 
4.3
 
Underwriting Agreement, dated as of November 19, 2007, among Wright Medical Group, Inc. and J.P. Morgan Securities Inc., Piper Jaffray & Co. and Wachovia Capital Markets, LLC. (5)