10-Q 1 slp135.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001 ---------------------------------------- OR [ ] 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 1-10670 HANGER ORTHOPEDIC GROUP, INC. --------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 84-0904275 -------------------------------------------------------------------------------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) Two Bethesda Metro Center, Suite 1200, Bethesda, MD 20814 ---------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (301) 986-0701 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- Former name, former address and former fiscal year, if changed since last report. Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --------------- --------------- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of November 5, 2001: 18,910,002 shares of common stock, $.01 par value per share. HANGER ORTHOPEDIC GROUP, INC. INDEX Page No. Part I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets - September 30, 2001 (unaudited) and December 31, 2000 1-2 Consolidated Statements of Operations for the three months ended September 30, 2001 and 2000 (unaudited) 3 Consolidated Statements of Operations for the nine months ended September 30, 2001 and 2000 (unaudited) 4 Consolidated Statements of Cash Flows for the nine months ended September 30, 2001 and 2000 (unaudited) 5 Notes to Consolidated Financial Statements (unaudited) 6-15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 16-22 Item 3. Quantitative and Qualitative Disclosures About Market Risk 23 Part II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 24 SIGNATURES 25 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except share and per share amounts)
September 30, 2001 December 31, 2000 ------------------ ------------------- (Unaudited) ASSETS CURRENT ASSETS Cash and cash equivalents $ 3,459 $ 20,669 Accounts receivable, less allowances for doubtful accounts of $20,748 and $23,005 in 2001 and 2000, respectively 110,768 111,210 Inventories 49,395 61,223 Prepaid expenses and other assets 2,766 4,262 Income taxes receivable 6,614 6,325 Net assets held for sale 17,930 -- Deferred income taxes 21,243 20,038 -------- -------- Total current assets 212,175 223,727 -------- -------- PROPERTY, PLANT AND EQUIPMENT Land 4,177 4,177 Buildings 8,670 8,876 Machinery and equipment 27,619 31,393 Furniture and fixtures 9,916 9,968 Leasehold improvements 17,564 16,925 -------- -------- 67,946 71,339 Less accumulated depreciation and amortization 29,418 24,345 -------- -------- 38,528 46,994 -------- -------- INTANGIBLE ASSETS Excess of cost over net assets acquired 474,800 490,724 Non-compete agreements 1,059 1,426 Patents 8,100 9,924 Assembled work force 7,000 7,000 Other intangible assets 1,125 1,165 -------- -------- 492,084 510,239 Less accumulated amortization 44,523 36,533 -------- -------- 447,561 473,706 -------- -------- OTHER ASSETS Debt issuance costs, net 16,977 15,917 Other Assets 1,065 1,474 -------- -------- Total other assets 18,042 17,391 -------- -------- TOTAL ASSETS $716,306 $761,818 ======== ========
The accompanying notes are an integral part of the consolidated financial statements. 1 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except share and per share amounts)
September 30, 2001 December 31, 2000 ------------------ ----------------- (Unaudited) LIABILITIES, REDEEMABLE PREFERRED STOCK & SHAREHOLDERS' EQUITY CURRENT LIABILITIES Current portion of long-term debt $ 32,300 $ 37,595 Accounts payable 10,919 17,809 Accrued expenses 5,623 9,380 Accrued interest payable 6,850 7,559 Accrued wages and payroll taxes 21,381 17,385 Deferred revenue 145 309 --------- --------- Total current liabilities 77,218 90,037 --------- --------- Long-term debt, less current portion 391,689 422,838 Deferred income taxes 27,422 26,026 Other liabilities 4,341 2,656 --------- --------- Total Liabilities 500,670 541,557 --------- --------- 7% Redeemable Convertible Preferred stock, liquidation preference $1,000 per share 69,494 65,881 --------- --------- SHAREHOLDERS' EQUITY Common stock, $.01 par value; 60,000,000 shares authorized, 18,910,002 shares issued and outstanding in 2001 and 2000 190 190 Additional paid-in capital 146,498 146,498 Retained earnings 110 8,348 --------- --------- 146,798 155,036 Treasury stock, cost -- (133,495 shares) (656) (656) --------- --------- 146,142 154,380 --------- --------- TOTAL LIABILITIES, REDEEMABLE PREFERRED STOCK & SHAREHOLDERS' EQUITY $ 716,306 $ 761,818 ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 2 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED September 30, 2001 and 2000 (Dollars in thousands, except share and per share amounts) (unaudited)
2001 2000 ------------ ------------ Net sales $ 129,605 $ 125,252 Cost of products and services sold 61,606 60,822 ------------ ------------ Gross profit 67,999 64,430 Selling, general and administrative 47,524 41,748 Depreciation and amortization 3,310 2,914 Amortization of excess cost over net assets acquired 3,087 3,037 Integration costs -- 305 Adjustment to impairment loss on assets held for sale (147) -- ------------ ------------ Income from operations 14,225 16,426 Other (expense) income: Interest expense, net (10,768) (12,170) Other, net 205 (108) ------------ ------------ Income before income taxes 3,662 4,148 Provision for income taxes 3,679 2,552 ------------ ------------ Net income (loss) $ (17) $ 1,596 ============ ============ Net income (loss) applicable to common stock $ (1,242) $ 339 ============ ============ Basic Per Common Share Data Net income (loss) applicable to common stock $ (0.07) $ 0.02 ============ ============ Shares used to compute basic per common share amounts 18,910,002 18,910,002 ============ ============ Diluted for Common Share Data Net Income applicable to common stock* $ (0.07) $ 0.02 ============ ============ Shares used to compute diluted per common share amounts 18,910,002 18,997,841 ============ ============ * Excludes the effect of the conversion of the 7% Redeemable Preferred Stock into common stock as it is anti-dilutive. All other outstanding options and warrants are anti-dilutive due to the net loss applicable to the Company's common shareholders for the three and nine months ended September 30, 2001.
The accompanying notes are an integral part of the consolidated financial statements. 3 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED September 30, 2001 and 2000 (Dollars in thousands, except share and per share amounts) (unaudited)
2001 2000 ------------ ------------ Net sales $ 379,365 $ 365,992 Cost of products and services sold 188,014 178,316 ------------ ------------ Gross profit 191,351 187,676 Selling, general and administrative 135,966 123,756 Depreciation and amortization 9,702 8,570 Amortization of excess cost over net assets acquired 9,206 8,825 Restructuring and asset impairment costs 3,688 -- Integration costs -- 1,393 Impairment loss on assets held for sale 8,029 -- ------------ ------------ Income from operations 24,760 45,132 Other (expense) income: Interest expense, net (34,059) (34,278) Other, net 346 (142) ------------ ------------ Income (loss) before income taxes (8,953) 10,712 Provision (benefit) for income taxes (4,328) 6,990 ------------ ------------ Net income (loss) $ (4,625) $ 3,722 ============ ============ Net income (loss) applicable to common stock $ (8,238) $ 161 ============ ============ Basic Per Common Share Data Net income (loss) applicable to common stock $ (0.44) $ 0.01 ============ ============ Shares used to compute basic per common share amounts 18,910,002 18,910,002 ============ ============ Diluted per Common Share Data Net income applicable to common stock * $ (0.44) $ 0.01 ============ ============ Shares used to compute basic per common share amounts 18,910,002 19,065,191 ============ ============ * Excludes the effect of the conversion of the 7% Redeemable Preferred Stock into common stock as it is anti-dilutive. All other outstanding options and warrants are anti-dilutive due to the net loss applicable to the Company's common shareholders for the three and nine months ended September 30, 2001.
The accompanying notes are an integral part of the consolidated financial statements. 4 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED September 30, 2001 and 2000 (Dollars in thousands) (unaudited)
2001 2000 -------- -------- Cash flows from operating activities: Net income (loss) $ (4,625) $ 3,722 -------- -------- Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Impairment loss on assets held for sale 8,029 -- Provision for bad debts 16,143 12,986 Deferred income taxes 191 -- Depreciation and amortization 9,702 8,570 Amortization of excess cost over net assets acquired 9,206 8,825 Amortization of debt issuance costs 1,931 1,474 Restructuring costs 3,688 -- Changes in assets and liabilities, net of effects from acquired companies: Accounts receivable (16,785) (28,899) Inventories 8,733 (9,774) Prepaid and other assets 1,188 232 Other assets 374 545 Accounts payable (6,773) 115 Accrued expenses (8,404) 7,789 Accrued wages & payroll taxes 4,383 (3,070) Other liabilities 1,685 (1,612) -------- -------- Total adjustments 33,291 (2,819) -------- -------- Net cash provided by operating activities 28,666 903 -------- -------- Cash flows from investing activities: Purchase of fixed assets (4,268) (7,965) Acquisitions/earn-outs, net of cash acquired (4,732) (6,773) Cash received pursuant to purchase price adjustment -- 22,850 Other intangibles -- (27) -------- -------- Net cash provided by (used in) investing activities (9,000) 8,085 -------- -------- Cash flows from financing activities: Borrowings (repayments) under revolving credit facility (6,900) 10,300 Repayment of term loans (18,500) (5,500) Repayment of long-term debt (10,416) (10,536) Increase in financing costs (1,060) (1,159) -------- -------- Net cash used by financing activities (36,876) (6,895) -------- -------- Net change in cash and cash equivalents for the period (17,210) 2,093 Cash and cash equivalents at beginning of period 20,669 5,735 -------- -------- Cash and cash equivalents at end of period $ 3,459 $ 7,828 ======== ======== Supplemental disclosure of cash flow information: Cash paid during the period for: Interest $ 34,086 $ 26,167 ======== ======== Taxes $ 976 $ 2,237 ======== ======== Non-cash financing and investing activities: Issuance of notes in connection with acquisitions $ -- $ 2,174 ======== ======== Dividends declared on preferred stock $ 3,558 $ 3,506 ======== ======== Accretion of preferred stock $ 55 $ 55 ======== ========
The accompanying notes are an integral part of the consolidated financial statements. 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars In Thousands, Except Shares and Per Share Amounts) NOTE A -- BASIS OF PRESENTATION The accompanying unaudited financial statements have been prepared in accordance with Rule 10-01 of Regulation S-X. They do not include all of the information and notes required by generally accepted accounting principles ("GAAP") for complete financial statements. In the opinion of management, all adjustments, considered necessary for a fair presentation of the financial statements have been included. Certain reclassifications of prior year's data have been made to improve comparability. Significant Accounting Principles The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. These financial statements should be read in conjunction with the financial statements of Hanger Orthopedic Group, Inc. (the "Company") and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2000, filed by the Company with the Securities and Exchange Commission. Inventories, which consist principally of purchased parts, are stated at the lower of cost or market using the first-in, first-out (FIFO) method. The Company calculates cost of goods sold in accordance with the gross profit method. The Company bases the estimates used in applying the gross profit method on the actual results of the most recently completed fiscal year and other factors affecting cost of goods sold during the current reporting periods. Estimated cost of goods sold during the period is adjusted when the annual physical inventory is taken. 6 NOTE B - SEGMENT AND RELATED INFORMATION The Company evaluates segment performance and allocates resources based on the segments' EBITDA. "EBITDA" is defined as income from operations before interest, taxes, depreciation and amortization. EBITDA is not a measure of performance under GAAP. While EBITDA should not be considered in isolation or as a substitute for net income, cash flows from operating activities and other income or cash flow statement data prepared in accordance with GAAP, or as a measure of profitability or liquidity, management understands that EBITDA is customarily used as a criteria in evaluating heath care companies. Moreover, substantially all of the Company's financing agreements contain covenants in which EBITDA is used as a measure of financial performance. EBITDA is presented for each reported segment before reclassifications between EBITDA and other income (expense) made for external reporting purposes. "Other" EBITDA not directly attributable to reportable segments is primarily related to corporate general and administrative expenses. In anticipation of the sale of the manufacturing segment, the Company moved the reporting of the Sea-Fab business to the patient care segment. The 2000 data has been restated to be consistent with 2001 reporting in that the Sea-Fab activity was moved from manufacturing to patient care. 7 Summarized financial information concerning the Company's reportable segments is shown in the following table:
Practice Management Other And Patient and Care Centers Manufacturing Distribution Eliminations Total Three Months Ended September 30, 2001 Net Sales Customers $ 120,893 $ 1,535 $ 7,177 $ -- $ 129,605 ========= ========= ========= ========= ========= Intersegments $ -- $ 1,323 $ 13,598 $ (14,921) $ -- ========= ========= ========= ========= ========= EBITDA $ 25,515 $ (466) $ 1,266 $ (5,840) $ 20,475 Restructuring costs and integration expense -- -- -- -- -- Depreciation and amortization (5,315) (438) (116) (528) (6,397) Interest expense, net (12,590) (16) -- 1,838 (10,768) Other income 132 46 -- 27 205 Impairment loss on assets held for sale -- 147 -- -- 147 --------- --------- --------- --------- --------- Income (loss) before taxes $ 7,742 $ (727) $ 1,150 $ (4,503) $ 3,662 ========= ========= ========= ========= ========= Three Months Ended September 30, 2000 * Net Sales Customers $ 115,936 $ 1,942 $ 7,374 $ -- $ 125,252 ========= ========= ========= ========= ========= Intersegments $ 2,384 $ 1,691 $ 12,756 $ (16,831) $ -- ========= ========= ========= ========= ========= EBITDA $ 25,723 $ 309 $ 1,929 $ (5,279) $ 22,682 Restructuring costs and integration expense (147) -- -- (158) (305) Depreciation and amortization (5,172) (400) (91) (288) (5,951) Interest expense, net (12,733) (4) -- 567 (12,170) Other (income) (109) 4 -- (3) (108) --------- --------- --------- --------- --------- Income (loss) before taxes $ 7,562 $ (91) $ 1,838 $ (5,161) $ 4,148 ========= ========= ========= ========= ========= Nine Months Ended September 30, 2001 Net Sales Customers $ 351,927 $ 4,749 $ 22,689 $ -- $ 379,365 ========= ========= ========= ========= ========= Intersegments $ -- $ 3,562 $ 40,318 $ (43,880) $ -- ========= ========= ========= ========= ========= EBITDA $ 70,702 $ (304) $ 4,538 $ (19,551) $ 55,385 Restructuring costs and Integration expense (3,604) (84) -- -- (3,688) Depreciation and amortization (15,938) (1,292) (335) (1,343) (18,908) Interest expense, net (37,931) (270) -- 4,142 (34,059) Other income (expense) 127 108 3 108 346 Impairment loss on assets held for sale -- (8,029) -- -- (8,029) --------- --------- --------- --------- --------- Income (loss) before taxes $ 13,356 $ (9,871) $ 4,206 $ (16,644) $ (8,953) ========= ========= ========= ========= ========= Nine Months Ended September 30, 2000 * Net Sales Customers $ 337,395 $ 6,932 $ 21,665 $ -- $ 365,992 ========= ========= ========= ========= ========= Intersegments $ 7,201 $ 4,498 $ 39,279 $ (50,978) $ -- ========= ========= ========= ========= ========= EBITDA $ 73,686 $ 757 $ 5,646 $ (16,169) $ 63,920 Restructuring costs and integration expense (895) -- (6) (492) (1,393) Depreciation and amortization (15,286) (1,104) (243) (762) (17,395) Interest expense, net (37,779) (11) -- 3,512 (34,278) Other (income) expense (163) 25 (1) (3) (142) --------- --------- --------- --------- --------- Income (loss) before taxes $ 19,563 $ (333) $ 5,396 $ (13,914) $ 10,712 ========= ========= ========= ========= ========= * Included the transfer of Sea-Fab in 2000 from the manufacturing to the patient care segments to be consistent with 2001 reporting.
8 NOTE C -- INVENTORY Inventories at September 30, 2001 and December 31, 2000 were comprised of the following: September 30, 2001 December 31, 2000 ------------------ ----------------- (unaudited) Raw materials $20,861 $29,482 Work-in-process 19,829 19,885 Finished goods 8,705 11,856 --------- -------- $49,395 $61,223 ========= ======== NOTE D - ACQUISITIONS During the first nine months of 2000, the Company acquired four orthotic and prosthetic companies. The aggregate purchase price, excluding potential earn-out provisions, was $3,000, comprised of $1,600 in cash and $1,400 in promissory notes. The Company has not acquired any companies during 2001. Additionally, the Company paid, during the nine-month period ending September 30, 2001, approximately $4,732 related to orthotic and prosthetic companies acquired in years prior to 2001. The payments were primarily made pursuant to earnout provisions contained in the respective acquisition agreements. The Company has accounted for these amounts as additional purchase price resulting in an increase to excess of cost over net assets acquired in the amount of $4,732. Additional amounts aggregating approximately $6,500 may be paid in connection with earnout provisions contained in previous acquisition agreements. NOTE E - INTEGRATION, RESTRUCTURING, & ASSET IMPAIRMENT COSTS In connection with the acquisition of NovaCare Orthotics & Prosthetics, Inc. ("NovaCare O&P") on July 1, 1999, the Company implemented a restructuring plan as of that date. The plan contemplated lease termination and severance costs associated with the closure of certain redundant patient-care centers and corporate functions of the Company and NovaCare O&P. The costs associated with the former NovaCare O&P centers were recorded in connection with the purchase price allocation on July 1, 1999. The costs associated with the existing Company centers were charged to operations during the third quarter of 1999. As of December 31, 2000, the reduction in work force had been completed and the patient care centers identified for closure, closed. Lease payments on closed patient care centers identified are expected to be paid through 2003. As of June 30, 2001, management reversed $771 of the lease termination restructuring reserve. This benefit resulted from favorable lease buyouts and sublease activity. In December of 2000, management and the Board of Directors determined that major performance improvement initiatives needed to be adopted. Two hundred thirty-four (234) 9 employees were severed in an effort to reduce general and administrative costs and the Company retained Jay Alix & Associates ("JA&A") to do an assessment of the opportunities available for improved financial and operating performance. As of December 31, 2000, the Company recorded approximately $700 in restructuring liabilities. These amounts were paid in January of 2001. Upon their retention, JA&A began the development of a comprehensive performance improvement program which consists of fourteen performance improvement initiatives aimed at improving cash collections, reducing working capital requirements and improving operating performance. In connection with the implementation of the JA&A initiatives, the Company recorded in the second quarter of 2001 approximately $3,688 in restructuring and asset impairment costs ($4,459 expense offset by the above mentioned $771 benefit). The plan calls for the closure of 37 facilities and the termination of approximately 135 additional employees. As of September 30, 2001, 35 of the facilities had been vacated and 86 of the employees had been terminated. Actions under this plan are expected to be completed by December 31, 2001. Payments under the plan for lease and severance costs are expected to be paid by December 31, 2003. Components of the restructuring reserves, spending during the year, and the remaining reserve balance are as follows:
Lease Employee Termination Total Severance and Other Restructuring Costs Exit Costs Reserve ------------ ------------- ------------- Balance at December 31, 2000 $ 693 $ 1,407 $ 2,100 Spending (693) (211) (904) Amendment to plan -- (771) (771) ------- ------- ------- Balance of 1999 and 2000 restructuring reserves at September 30, 2001 $ -- $ 425 $ 425 Second quarter 2001 restructuring charge 1,208 3,251* 4,459 Spending (627) (1,146) (1,773) ------- ------- ------- Balance of 2001 restructuring reserve at September 30, 2001 $ 581 $ 2,105 $ 2,686 ------- ------- ------- Total restructuring reserve balance at September 30, 2001 $ 581 $ 2,530 $ 3,111 ======= ======= =======
* Includes $484 of asset impairment for impaired leasehold improvements at branches to be vacated. 10 NOTE F - AGREEMENT WITH JAY ALIX & ASSOCIATES On December 11, 2000, the Company retained the services of JA&A to assist in identifying areas for cash generation and profit improvement. Subsequent to the completion of this diagnostic phase, the Company modified and extended the retention agreement on January 23, 2001 to include the implementation of certain restructuring activities. Among the targeted plans are spending reductions, improving the utilization and effectiveness of support services, including claims processing, the refinement of materials purchasing and inventory management and the consolidation of distribution services. In addition, the Company will seek to enhance revenues and cash collections through improved marketing efforts and more efficient billing procedures. The terms of this engagement provide for payment of JA&A's normal hourly fees plus a success fee if certain defined benefits are achieved. Management has elected to pay one-half of any earned success fee in cash, with the remaining one-half of the success fee paid through a grant of options to purchase the Company's common stock. All the options will be granted with an exercise price of $1.40 per share, which was the average closing price of the Company's common stock for all trading days during the period from December 23, 2000 through January 23, 2001. The number of options will be determined by multiplying the non-cash half of each success fee invoice of JA&A by 1.5 and dividing the product by $1.40. The options are to be granted within 30 days of each invoice, shall be exercisable beginning with the sixth month following each award and shall expire five years from the termination of JA&A's engagement. The number of options that will be granted cannot be determined at this time. As of September 30, 2001, none of the initiatives for which defined benefits may be measured and a success fee earned have been completed and therefore no options have been granted or cash payments accrued. 11 NOTE G- NET INCOME PER COMMON SHARE The following sets forth the calculation of the basic and diluted income per common share amounts for the three month periods ended September 30, 2001 and 2000 and the nine month periods ended September 30, 2001 and 2000.
Three Months Ended Nine Months Ended September 30, September 30, -------------------------------- -------------------------------- 2001 2000 2001 2000 ---- ---- ---- ---- Net income (loss) $ (17) $ 1,596 $ (4,625) $ 3,722 Less preferred stock accretion and dividends declared (1,225) (1,257) (3,613) (3,561) ------------ ------------ ------------ ------------ Income (loss) applicable to common stockholders used to compute basic per common share amounts (1,242) 339 (8,238) 161 Add back interest expense on convertible note payable, net of tax 0 15 0 50 ------------ ------------ ------------ ------------ Income (loss) applicable to common stockholders plus assumed conversions used to compute $ (1,242) $ 354 $ (8,238) $ 211 ============ ============ ============ ============ diluted per common share amounts Average shares of common stock outstanding used to compute basic per common share amounts 18,910,002 18,910,002 18,910,002 18,910,002 Effect of convertible note payable -- 69,430 -- 69,430 Effect of dilutive options -- 18,405 -- 55,927 Effect of dilutive warrants -- 4 -- 59,832 ------------ ------------ ------------ ------------ Shares used to compute dilutive per common share amounts (1) 18,910,002 18,997,841 18,910,002 19,095,191 ============ ============ ============ ============ Basic income (loss) per common share $ (.07) $ .02 $ (.44) $ .01 Diluted income per common share $ (.07) $ .02 $ (.44) $ .01 (1) Excludes the effect of the conversion of the 7% Redeemable Preferred Stock into common stock as it is anti-dilutive. All other outstanding options and warrants are anti-dilutive due to the net loss available to the Company's common shareholders for the three and nine months ended September 30, 2001.
NOTE H - LONG TERM DEBT The Company's total long term debt at September 30, 2001 including a current portion of $32,300, was $423,989. Such indebtedness included: (i) $150,000 of senior subordinated notes; 12 (ii) $77,800 for the revolver; (iii) $75,000 for Tranche A; (iv) $98,250 for Tranche B; and (v) a total of $22,939 of other indebtedness. At December 31, 2000, the Company was not in compliance with certain of the financial covenants under the Credit Agreement for interest coverage and leverage coverage. In consideration for the banks' waiver of the Company's non-compliance with these covenants, an amendment to the amended and restated Credit Agreement dated as of March 16, 2001, was entered into which provides for an increase in the Tranche A Term Facility and the Revolving Credit Facility annual interest rate to adjusted London Interbank Offering Rate ("LIBOR") plus 3.50% or Alternate Borrowing Rate ("ABR") plus 2.50%, and an increase in the Tranche B Term Facility annual interest rate to adjusted LIBOR plus 4.50% or ABR plus 3.50%. Certain of the financial covenants were eased with respect to 2001 and 2002 under the terms of the amendment to the Credit Agreement. As of September 30, 2001, the Company was in compliance with all of its financial covenants. Matters critical to the Company's compliance with the Credit Agreement covenants, and ultimately its immediate term liquidity (to the extent alternative sources of liquidity are not readily available), include improving operating results through revenue growth and cost control, and reducing the Company's investment in working capital. The Company's ability to continue to comply with the Credit Agreement covenants is dependent on certain factors, including (a) the ability of the Company to affect the restructuring initiatives referred to above, and (b) the Company's ability to continue to attract and retain experienced management and O&P practitioners. Unexpected increases in LIBOR could also adversely impact the Company's ability to comply with the Credit Agreement covenants. The Credit Agreement with the banks is collateralized by substantially all the assets of the Company, restricts payments of dividends, and contains certain affirmative and negative covenants customary in an agreement of this nature. NOTE I - COMMITMENTS AND CONTINGENCIES The Company is subject to legal proceedings and claims which arise in the ordinary course of its business, including claims related to alleged contingent additional payments under business purchase agreements. Many of these legal proceedings and claims existed in the NovaCare O&P business prior to the Company's acquisition of NovaCare O&P. In the opinion of management, the amount of ultimate liability, if any, with respect to these actions will not have a materially adverse effect on the financial position, liquidity or results of operations of the Company. On November 28, 2000, a class action complaint (Norman Ottmann v. Hanger Orthopedic Group, Inc., Ivan R. Sabel and Richard A. Stein; Civil Action No. 00CV3508) was filed against the Company in the United States District Court for the District of Maryland on behalf of all purchasers of our common stock from November 8, 1999 through and including January 6, 2000. The complaint also names as defendants Ivan R. Sabel, Chairman of the Board, President and Chief Executive Officer of the Company, and Richard A. Stein, former Chief Financial Officer, Secretary and Treasurer of the Company. 13 The complaint alleges that during the above period of time, the defendants violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934 by, among other things, knowingly or recklessly making material misrepresentations concerning the Company's financial results for the quarter ended September 30, 1999, and the progress of the Company's efforts to integrate the recently-acquired operations of NovaCare O&P. The complaint further alleges that by making those material misrepresentations, the defendants artificially inflated the price of the Company's common stock. The plaintiff seeks to recover damages on behalf of all of the class members. The Company believes that the allegations are without merit and plans to vigorously defend the lawsuit. NOTE J - NEW ACCOUNTING STANDARDS On June 29, 2001, the FASB unanimously approved its proposed Statements of Financial Accounting Standards No. 141 (SFAS 141), Business Combinations, and No. 142 (SFAS 142), Goodwill and Other Intangible Assets. SFAS 141 supercedes Accounting Principles Board (APB) Opinion No. 16, Business Combinations. The most significant changes made by SFAS 141 are: (1) requiring that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, (2) establishing specific criteria for the recognition of intangible assets separately from goodwill, and (3) requiring unallocated negative goodwill to be written off immediately as an extraordinary gain rather than being deferred and amortized. The Company does not expect a material impact from the adoption of SFAS 141 on its consolidated financial statements. SFAS 142 supercedes APB 17, Intangible Assets. SFAS 142 primarily addresses accounting for goodwill and intangible assets subsequent to their acquisition (i.e., the post-acquisition accounting). The provisions of SFAS 142 will be effective for fiscal years beginning after December 15, 2001. However, early adoption of SFAS 142 will be permitted for companies with a fiscal year beginning after March 15, 2001, provided their first quarter financial statements have not been previously issued. In all cases, SFAS 142 must be adopted at the beginning of a fiscal year. The most significant changes made by SFAS 142 are: (1) goodwill and indefinite lived intangible assets will no longer be amortized, (2) goodwill will be tested for impairment at least annually at the reporting unit level, (3) intangible assets deemed to have an indefinite life will be tested for impairment at least annually, and (4) the amortization period of intangible assets with finite lives will no longer be limited to forty years. The Company intends to adopt SFAS 142 effective January 1, 2002 and is currently evaluating the impact on its consolidated financial statements. In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," and SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 143 requires the accrual of asset retirement obligations by increasing the initial carrying amount of the related long-lived asset, and systematically expensing such costs over the asset's useful life. The standard is effective for fiscal years beginning after June 15, 2002. SFAS No. 144 supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to 14 Be Disposed Of," and expands the scope of discontinued operations. SFAS 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001. The Company does not expect SFAS No. 143 or 144 to have a material effect on its financial statements. NOTE K - SUBSEQUENT EVENTS On October 9, 2001, the Company completed the sale of substantially all of the manufacturing assets of Seattle Orthopedic Group, Inc., ("SOGI") to United States Manufacturing Company ("USMC"). The purchase price was $20 million. The Company also entered into a five-year supply agreement with USMC. The Company incurred an impairment loss of $8,029 on the disposal of SOGI's manufacturing assets which has been reflected in the Company's statement of operations. For the nine months ended September 30, 2001, the results of operations of SOGI's manufacturing activities, including intercompany transactions during that same period were: (In thousands) Sales $8,311 Cost of Sales 5,654 Gross Profit 2,657 SG&A 2,961 Restructuring 84 Operating Loss (388) Reconciliation of SOGI Transaction Accounts Receivable $ 1,079 Inventory 3,094 Net Fixed Assets 4,626 Net Intangibles 18,603 Other 60 Liabilities Assumed (1,503) --------- Net Book Value 25,959 Estimated Proceeds for Net Assets Held for sale 17,930 --------- Impairment loss on assets held for sale $ (8,029) ======== 15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations The following table sets forth for the periods indicated certain items of the Company's Statements of Operations and their percentage of the Company's net sales:
Three Months Nine Months Ended September 30, Ended September 30, 2001 2000 2001 2000 ---- ---- ---- ---- Net sales 100.0% 100.0% 100.0% 100.0% Cost of products and services sold 47.5 48.6 49.6 48.7 Gross profit 52.5 51.4 50.4 51.3 Selling, general & administrative expenses 36.7 33.3 35.8 33.8 Depreciation and amortization 2.6 2.3 2.6 2.3 Amortization of excess cost over net assets acquired 2.4 2.4 2.4 2.4 Restructuring and asset impairment costs -- -- 1.0 -- Integration costs -- 0.3 -- 0.4 Impairment loss on assets held for sale (0.1) -- 2.1 -- Income from operations 11.0 13.1 6.5 12.3 Interest expense 8.3 9.7 9.0 9.4 Provision for income taxes 2.8 2.0 (1.1) 1.9 Net income (loss) 0.0 1.3 (1.2) 1.0
Three Months Ended September 30, 2001 Compared to the Three Months Ended September 30, 2000 Net Sales Net sales for the quarter ended September 30, 2001, were approximately $129.6 million, an increase of approximately $4.4 million, or 3.5%, over net sales of approximately $125.3 million for the quarter ended September 30, 2000. The increase was attributable to strong organic growth from our patient care division slightly offset by a reduction in external sales of the manufacturing division. Gross Profit Gross profit in the quarter ended September 30, 2001 was approximately $68.0 million, an increase of approximately $3.6 million, or 5.5%, over gross profit of approximately $64.4 million for the quarter ended September 30, 2000. Gross profit as a percentage of net sales increased to 52.5% in the third quarter of 2001 from 51.4% in the third quarter of 2000. The increase in gross 16 profit as a percentage of sales was the result of lower labor expenses in the cost of products and services sold. Selling, General and Administrative Expenses Selling, general and administrative expenses in the quarter ended September 30, 2001 increased by approximately $5.8 million, or 13.8%, compared to the quarter ended September 30, 2000. Selling, general and administrative expenses as a percentage of net sales increased to 36.7% in the third quarter of 2001 compared to 33.3% for same period in 2000. The increase in selling, general and administrative expenses was primarily the result of (i) an increase of approximately $5.0 million in bonus costs caused by above-average collections and (ii) the expenditure of approximately $1.5 million in non-recurring expenses associated with the Jay Alix initiatives. Income from Operations Principally as a result of the above, income from operations in the quarter ended September 30, 2001 was approximately $14.2 million, a decrease of $2.2 million, or 13.4%, from the prior year's comparable quarter. Income from operations, as a percentage of net sales, decreased to 11.0% in the third quarter of 2001 from 13.1% in the prior year's comparable quarter. Interest Expense Net interest expense in the third quarter of 2001 was approximately $10.8 million, a decrease of approximately $1.4 million from the approximately $12.2 million incurred in the third quarter of 2000. Interest expense as a percentage of net sales in the third quarter of 2001 decreased to 8.3% from 9.7% for the same period a year ago. The decrease in interest expense was primarily attributable to a $14.3 million decrease in average borrowings and a 348 basis point reduction in LIBOR during the quarter ended September 30, 2001 compared to the same period of the prior year which was partially offset by the rate increase associated with the restructured covenants as discussed in Note H. Income Taxes The Company's effective tax rate was over 100% in the third quarter of 2001 versus 61.5% in the third quarter of 2000. The increase in the effective tax rate in 2001 was principally a result of the effect of non-deductible goodwill amortization, and low levels of pre-tax income. The provision for income taxes in the third quarter of 2001 was approximately $3.7 million compared to approximately $2.6 million for the third quarter of 2000. Net Income (Loss) As a result of the above, the Company recorded a net (loss) of $(17,000) in the quarter ended September 30, 2001, compared to net income of $1.6 million, or $.02 per dilutive common share, in the quarter ended September 30, 2000. 17 Nine Months Ended September 30, 2001 Compared to the Nine Months Ended September 30, 2000 Net Sales Net sales for the nine months ended September 30, 2001 were approximately $379.4 million, an increase of approximately $13.4 million, or 3.7%, over net sales of approximately $366.0 million for the nine months ended September 30, 2000. The increase was attributable to strong organic growth from our patient care division slightly offset by a reduction in external sales of the manufacturing division. Gross Profit Gross profit for the nine months ended September 30, 2001 was approximately $191.4 million, an increase of approximately $3.8 million, or 2.0%, over gross profit of approximately $187.7 million for the nine months ended September 30, 2000. The increase in gross profit was principally the result of the sales increase. Gross profit as a percentage of net sales was 50.4% in the first nine months of 2001 compared to 51.3% in the first nine months of 2000. Gross profit, as a percentage of sales, declined 90 basis points due to higher material costs. Selling, General and Administrative Expenses Selling, general and administrative expenses in the nine months ended September 30, 2001 increased by approximately $12.2 million, or 9.9%, compared to the nine months ended September 30, 2000. Selling, general and administrative expenses as a percentage of net sales increased to 35.8% in the nine months ended September 30, 2001, from 33.8% for the same period in 2000. The increase in selling, general and administrative expenses, both in dollar amount and as a percent of net sales, was primarily the result of (i) an increase of approximately $1.0 million in labor costs, (ii) an increase in legal and professional fees of approximately $3.0 million, (iii) an increase of approximately $3.2 million in bad debt expense, and (iv) approximately $4.5 million in non-recurring expenses associated with the Jay Alix initiatives. Restructuring and Asset Impairment Costs During the second quarter of 2001, the Company established a restructuring reserve totaling $3.7 million. These amounts consist of severance costs, lease and other exit costs. See also the discussion in Note E. Integration Costs The Company recognized approximately $1.4 million of one-time integration costs during the nine months ended September 30, 2000 in connection with the Company's acquisition on July 1, 1999 of NovaCare O&P. The approximately $1.4 million of integration costs recognized during the 18 nine months ended September 30, 2000, included (i) the $.3 million of computer conversion, consulting and related costs recognized during the quarter ended September 30, 2000, and (ii) approximately $1.1 million of costs of changing patient care center names, payroll and related benefit conversion, stay-bonuses and related benefits for transitional employees and certain other costs relating to the acquisition recognized during the nine months ended September 30, 2000. Impairment on Assets Held for Sale The Company recorded an impairment loss on assets held for sale of approximately $8.0 million in the second quarter of 2001. On August 10, 2001, the Board of Directors authorized the sale of substantially all of the manufacturing related assets of Seattle Orthopedic Group, Inc. (SOGI). After extensive review and analysis, the Company determined that the manufacture of orthotic and prosthetic components and devices was not a core business of Hanger as it represented only 1% of Hanger's revenue for the six months ended June 30, 2001 and 2% for the year ended December 31, 2000. The Company determined that its assets and management expertise can be more effectively deployed in its core business providing our orthotic and prosthetic patients with clinical excellence and superior customer service. The treatment and service to orthotic and prosthetic patients represented 92.5% of Hanger's revenues for the six months ended June 30, 2001 and 92.1% of revenues for the year ended December 31, 2000. The sale of SOGI's manufacturing assets was completed on October 9, 2001, and SOGI assets as of September 30, 2001 have a net carrying value of $17.9 million. The Company recorded an impairment loss of $8.0 million on the planned disposal of SOGI's manufacturing assets for the nine months ended September 30, 2001, which has been reflected in the Company's statement of operations. Income from Operations Principally as a result of the above, income from operations for the nine months ended September 30, 2001 was approximately $24.8 million, a decrease of approximately $20.4 million, or 45.1%, from the prior year's comparable period. Income from operations as a percentage of net sales decreased to 6.5% in the nine months ended September 30, 2001 from 12.3% in the nine months ended September 30, 2000. Interest Expense Net interest expense for the first nine months of 2001 was approximately $34.1 million, a decrease of approximately $0.2 million from approximately $34.3 million incurred in the first nine months of 2000. Interest expense as a percentage of net sales decreased to 9.0% in the nine months ended September 30, 2001 from 9.4% for the same period one year ago. The decrease in interest expense as a percentage of net sales is primarily attributable to several factors including a $6.6 million decrease in average borrowings and a 236 basis point reduction in LIBOR which was partially offset by the rate increase associated with the restructured covenants as discussed in Note H. 19 Income Taxes The Company's effective tax rate was a benefit of (48.3%) in the first nine months of 2001 versus 65.3% in the comparable period of 2000. The decrease in the effective tax rate in 2001 is principally a result of the pre-tax loss. The benefit for income taxes for the nine months ended September 30, 2001 was approximately $4.3 million compared to a provision of approximately $7.0 million for the nine months ended September 30, 2000. Net Income As a result of the above, the Company recorded a net loss of approximately $4.6 million, or $.44 per dilutive common share, in the first nine months of 2001, compared to net income of approximately $3.7 million, or $.01 per dilutive common share, in the first nine months of 2000. Liquidity and Capital Resources Cash flow provided by operating activities for the nine month period ended September 30, 2001 was $28.7 million, an increase of $27.8 million compared to same period last year. The increase resulted from significant improvements in working capital during the first nine months of 2001. The Company's consolidated liquidity position (comprised of cash and cash equivalents and unused credit facilities) approximated $25.7 million at September 30, 2001 compared to approximately $36.0 million at December 31, 2000. Consolidated working capital at September 30, 2001 was approximately $135.0 million compared to the December 31, 2000 level of $133.7 million. The Company's total long term debt at September 30, 2001, including a current portion of approximately $32.3 million, was approximately $424.0 million. Such indebtedness included: (i) $150.0 million of 11.25% Senior Subordinated Notes due 2009; (ii) $77.8 million for the Revolving Credit Facility; (iii) $75.0 million for the Tranche A Term Facility; (iv) $98.3 million for the Tranche B Term Facility; and (v) a total of $22.9 million of other indebtedness. The Revolving Credit Facility, and the Tranche A and B Term Facilities (the "Credit Facility") were entered into with The Chase Manhattan Bank, Bankers Trust Company, Paribas and certain other banks (the "Banks") in connection with the Company's acquisition of NovaCare O&P, Inc. on July 1, 1999. The Revolving Credit Facility matures on July 1, 2005; the Tranche A Term Facility is payable in quarterly installments of $5.0 million through July 1, 2005; and the Tranche B Term Facility is payable in quarterly installments of $250.0 through December 31, 2004 and in quarterly installments of $15.8 million thereafter, through January 1, 2007. The Company used $14.9 million of the proceeds from its sale of Seattle Orthopedic Group, Inc. assets on October 9, 2001 to reduce its long-term debt under the Credit Facility. The Credit Facility contains certain affirmative and negative covenants customary in an agreement of this nature. At December 31, 2000, the Company was not in compliance with the financial covenants 20 under the Credit Agreement for interest coverage and leverage coverage. In consideration for the banks' waiver of the Company's non-compliance with these covenants, an amendment to the amended and restated Credit Agreement dated as of March 16, 2001 was entered into which provides for an increase in the interest rates of the Credit Facility borrowings by 50 basis points. As of September 30 2001, the Company was in compliance with all of its financial covenants. Matters critical to the Company's compliance with the Credit Agreement's covenants, and ultimately its immediate term liquidity (to the extent alternative sources of liquidity are not readily available), include improving operating results, through revenue growth and cost control, and reducing the Company's investment in working capital. As previously discussed, the Company has retained the services of Jay Alix & Associates to assist in identifying programs aimed at achieving these objectives. The Company's ability to continue to comply with the Credit Agreement is dependent on certain factors, including (a) the ability of the Company to affect the restructuring initiatives referred to above, and (b) the Company's ability to continue to attract and retain experienced management and O&P practitioners. Unexpected increases in the LIBOR rate could also adversely impact the Company's ability to comply with the Credit Agreement's covenants. Management believes that the Company will continue to comply with the terms of the Credit Facility and that the Company's consolidated liquidity position is adequate to meet its short term and long term obligations. The Credit Facility is collateralized by substantially all of the Company's assets, restricts the payment of dividends and restricts the Company from pursuing acquisition opportunities for the calendar year 2001. All or any portion of outstanding loans under the Credit Agreement may be repaid at any time and commitments may be terminated in whole or in part at the Company's option without premium or penalty, except that LIBOR-based loans may only be repaid at the end of the applicable interest period. Mandatory prepayments will be required in the event of certain sales of assets, debt or equity financings and under certain other circumstances. The $60.0 million of outstanding shares of 7% Redeemable Preferred Stock are convertible into shares of the Company's non-voting common stock at a price of $16.50 per share, subject to adjustment. The Company is entitled to require that the 7% Redeemable Preferred Stock be converted into non-voting common stock on and after July 2, 2002, if the average closing price of the common stock for 20 consecutive trading days is equal to or greater than 175% of the conversion price. The 7% Redeemable Preferred Stock will be mandatorily redeemable on July 1, 2010 at a redemption price equal to the liquidation preference plus all accrued and unpaid dividends. In the event of a change in control, the Company must offer to redeem all of the outstanding 7% Redeemable Preferred Stock at a redemption price equal to 101% of the sum of the per share liquidation preference thereof plus all accrued and unpaid dividends through the date of payment. The 7% Redeemable Preferred Stock accrues annual dividends, compounded quarterly, equal to 7%, and will not require principal payments prior to maturity on July 1, 2010. Other Inflation has not had a significant effect on the Company's operations, as increased costs to the Company 21 generally have been offset by increased prices of products and services sold. The Company primarily provides services and customized devices throughout the United States and is reimbursed, in large part, by the patients' third-party insurers or governmentally funded health insurance programs. The ability of the Company's debtors to meet their obligations is principally dependent upon the financial stability of the insurers of the Company's patients and future legislation and regulatory actions. Forward Looking Statements This report contains forward-looking statements setting forth the Company's beliefs or expectations relating to future revenues. Actual results may differ materially from projected or expected results due to changes in the demand for the Company's O&P services and products, uncertainties relating to the results of operations or recently acquired and newly acquired O&P patient care practices, the Company's ability to successfully integrate the operations of NovaCare O&P and to attract and retain qualified O&P practitioners, governmental policies affecting O&P operations and other risks and uncertainties affecting the health-care industry generally. Readers are cautioned not to put undue reliance on forward-looking statements. The Company disclaims any intent or obligation to up-date publicly these forward-looking statements, whether as a result of new information, future events or otherwise. 22 Item 3. Quantitative and Qualitative Disclosures About Market Risk In the normal course of business, the Company is exposed to fluctuations in interest rates. The Company addresses this risk by using interest rate swaps from time to time. At September 30, 2001, there were no interest rate swaps outstanding. 23 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. None (b) Forms 8-K. No reports on Form 8-K were filed during the quarter ended September 30, 2001. 24 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HANGER ORTHOPEDIC GROUP, INC. Date: November 13, 2001 /s/ IVAN R. SABEL ----------------------------------------- Ivan R. Sabel Chairman of the Board, President and Chief Executive Officer Date: November 13, 2001 /s/ GEORGE E. MCHENRY ----------------------------------------- George E. McHenry Executive Vice President - Finance, Principal Financial and Accounting Officer 25