10-Q 1 slp348.txt QUARTERLY REPORT 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 June 30, 2002 --------------------------------------------- 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 August 8, 2002; 19,512,213 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 - June 30, 2002 (unaudited) and December 31, 2001 1 Consolidated Statements of Operations for the three and six months ended June 30, 2002 and 2001 (unaudited) 3 Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001 (unaudited) 4 Notes to Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 24 Item 3. Quantitative and Qualitative Disclosures About Market Risk 33 Part II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders 34 Item 6. Exhibits and Reports on Form 8-K 35 SIGNATURES 36 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except share and per share amounts)
June 30, December 31, 2002 2001 ----------- ------------ (unaudited) ASSETS CURRENT ASSETS Cash and cash equivalents $ 15,201 $ 10,043 Accounts receivable, less allowances for doubtful accounts of $15,372 and $17,625 in 2002 and 2001, respectively 105,995 104,040 Inventories 52,550 55,946 Prepaid, other assets, and income taxes receivable 5,439 4,901 Deferred income taxes 20,957 20,957 -------- -------- Total current assets 200,142 195,887 -------- -------- PROPERTY, PLANT AND EQUIPMENT Land 3,743 4,078 Buildings 6,700 8,629 Machinery and equipment 31,183 28,675 Furniture and fixtures 10,162 9,967 Leasehold improvements 18,633 18,027 -------- -------- 70,421 69,376 Less accumulated depreciation and amortization 35,344 31,598 -------- -------- 35,077 37,778 -------- -------- INTANGIBLE ASSETS Excess cost over net assets acquired, less accumulated amortization of $38,915 and $36,727 in 2002 and 2001, respectively 448,447 440,874 Assembled workforce, less accumulated amortization of $0 and $2,188 in 2002 and 2001, respectively -- 4,812 Patents and other intangible assets, less accumulated amortization of $3,919 and $3,430 in 2002 and 2001, respectively 6,209 6,694 -------- -------- 454,656 452,380 -------- -------- OTHER ASSETS Debt issuance costs, net 14,604 10,846 Other assets 3,917 3,016 -------- -------- Total other assets 18,521 13,862 -------- -------- TOTAL ASSETS $708,396 $699,907 ======== ========
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)
June 30, December 31, 2002 2001 ------------ ------------ (unaudited) LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Current portion of long-term debt $ 9,104 $ 30,512 Accounts payable 7,388 16,901 Accrued expenses 9,459 8,196 Accrued interest payable 7,911 2,017 Accrued compensation related cost 22,677 29,045 Accrued income taxes 4,412 -- --------- --------- Total current liabilities 60,951 86,671 Long-term debt, less current portion 391,438 367,315 Deferred income taxes 26,495 26,495 Other liabilities 1,855 3,013 --------- --------- Total liabilities 480,739 483,494 --------- --------- 7% Redeemable Convertible Preferred stock, liquidation preference $1,000 per share 73,296 70,739 --------- --------- Commitments and contingent liabilities (See Note I) SHAREHOLDERS' EQUITY Common stock, $.01 par value; 60,000,000 shares authorized, 19,467,018 and 19,057,876 shares issued and outstanding in 2002 and 2001, respectively 195 191 Additional paid-in capital 148,721 146,674 Retained earnings (accumulated deficit) 6,101 (535) --------- --------- 155,017 146,330 Treasury stock, cost -- (133,495 shares) (656) (656) --------- --------- 154,361 145,674 --------- --------- TOTAL LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY $ 708,396 $ 699,907 ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 2 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS For the Three and Six Months Ended June 30, (Dollars in thousands, except share and per share amounts)
Three Months Six Months Ended June 30, Ended June 30, ------------------------------- ------------------------------ 2002 2001 2002 2001 -------------- -------------- ------------ ------------ (unaudited) (unaudited) Net sales $ 133,056 $ 129,187 $ 256,566 $ 249,760 Cost of goods sold 61,298 63,434 120,835 126,408 ------------ ------------ ------------ ------------ Gross profit 71,758 65,753 135,731 123,352 Selling, general and administrative 46,582 42,638 91,359 85,327 Depreciation and amortization 2,294 3,115 5,078 5,954 Amortization of excess cost over net assets acquired -- 3,292 -- 6,557 Unusual charges -- 13,324 -- 14,839 ------------ ------------ ------------ ------------ Income from operations 22,882 3,384 39,294 10,675 Interest expense, net 9,977 11,033 19,056 23,291 ------------ ------------ ------------ ------------ Income (loss) before taxes 12,905 (7,649) 20,238 (12,616) Provision (benefit) for income taxes 5,234 (2,908) 8,234 (8,007) ------------ ------------ ------------ ------------ Income (loss) before extraordinary item 7,671 (4,741) 12,004 (4,609) Extraordinary loss on early extinguishment of debt, net of tax benefit -- -- 2,811 -- ------------ ------------ ------------ ------------ Net income (loss) $ 7,671 $ (4,741) $ 9,193 $ (4,609) ============ ============ ============ ============ Income (loss) before extraordinary item applicable to common stock $ 6,380 $ (5,945) $ 9,447 $ (6,997) ============ ============ ============ ============ Net income (loss) applicable to common stock $ 6,380 $ (5,945) $ 6,636 $ (6,997) ============ ============ ============ ============ Basic Per Common Share Data Income (loss) before extraordinary item $ 0.33 $ (0.31) $ 0.49 $ (0.37) Extraordinary item, net of tax benefit -- -- (0.14) -- ------------ ------------ ------------ ------------ Net income (loss) $ 0.33 $ (0.31) $ 0.35 $ (0.37) ============ ============ ============ ============ Shares used to compute basic per common share amounts 19,336,954 18,910,002 19,221,865 18,910,002 ============ ============ ============ ============ Diluted Per Common Share Data Income (loss) before extraordinary item $ 0.29 $ (0.31) $ 0.44 $ (0.37) Extraordinary item, net of tax benefit -- -- (0.13) -- ------------ ------------ ------------ ------------ Net income (loss) $ 0.29 $ (0.31) $ 0.31 $ (0.37) ============ ============ ============ ============ Shares used to compute diluted per common share amounts 22,013,471 18,910,002 21,669,180 18,910,002 ============ ============ ============ ============
The accompanying notes are an integral part of the consolidated financial statements. 3 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the Six Months Ended June 30, (Dollars in thousands)
2002 2001 ----------- ----------- Cash flows from operating activities: (unaudited) Net income (loss) $ 9,193 $ (4,609) Adjustments to reconcile net income to net cash provided by operating activities: Extraordinary loss on extinguishment of debt 2,811 -- Loss on disposal of assets 557 8,176 Provision for bad debts 10,725 10,628 Depreciation and amortization 5,078 5,954 Amortization of excess cost over net assets acquired -- 6,557 Amortization of debt issuance costs 1,099 1,273 Deferred income taxes -- 945 Restructuring costs -- 3,688 Changes in assets and liabilities: Accounts receivable (12,681) (8,420) Inventories 3,397 8,088 Prepaid, other assets, and income taxes receivable (1,570) (5,172) Other assets (180) 234 Accounts payable (9,325) (3,880) Accrued expenses, interest and income taxes 14,419 (9,070) Accrued compensation related costs (6,368) (3,295) Other liabilities (1,159) 1,635 --------- --------- Net cash provided by operating activities 15,996 12,732 --------- --------- Cash flows from investing activities: Purchase of fixed assets (3,936) (3,701) Acquisitions, net of cash acquired, and earnouts (2,952) (2,783) Proceeds from sale of fixed assets 1,492 444 --------- --------- Net cash used in investing activities (5,396) (6,040) --------- --------- Cash flows from financing activities: Net repayments under revolving credit agreement (38,800) 4,000 Proceeds from sale of Senior Notes 200,000 -- Repayment and termination of bank loans (153,587) (13,250) Scheduled repayment of long-term debt (5,619) (6,969) Increase in financing costs (9,487) (1,059) Proceeds from issuance of Common Stock 2,051 -- --------- --------- Net cash used in financing activities (5,442) (17,278) --------- --------- Increase (decrease) in cash and cash equivalents 5,158 (10,586) Cash and cash equivalents at beginning of period 10,043 20,669 --------- --------- Cash and cash equivalents at end of period $ 15,201 $ 10,083 ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 4 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 the prior year's data have been made to improve comparability. 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 of Form 10-K for the year ended December 31, 2001, filed by the Company with the Securities and Exchange Commission. NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES Use of Estimates The preparation of financial statements in conformity with GAAP 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 revenues and expenses during the reporting period. Actual results could differ from those estimates. Also, see "Critical Accounting Estimates" in Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations. Inventories Inventories, which consist principally of purchased parts and work in process, 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. Change in Accounting for Goodwill and Certain Other Intangibles Effective July 1, 2001 the Company adopted certain provisions of SFAS No. 141, and effective January 1, 2002, the Company adopted the full provisions of SFAS No. 141 and SFAS No. 142. 5 NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES (CONTINUED) Change in Accounting for Goodwill and Certain Other Intangibles (Continued) SFAS No. 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting, and broadens the criteria for recording intangible assets apart from goodwill. The Company evaluated its goodwill and intangibles acquired prior to June 30, 2001 using the criteria of SFAS No. 141, which resulted in other intangibles with an unamortized balance of $4.8 million (comprised entirely of assembled workforce intangibles) being combined into goodwill at January 1, 2002. SFAS No. 142 requires that purchased goodwill and certain indefinite-lived intangibles no longer be amortized, but instead be tested for impairment at least annually. The Company evaluated its intangible assets, other than goodwill, and determined that all such assets have determinable lives. SFAS No. 142 prescribes a two-phase process for impairment testing of goodwill. The first phase, required to be completed by June 30, 2002, screens for impairment; while the second phase (if necessary), required to be completed by December 31, 2002, measures the impairment. The Company has completed the transitional impairment test, which did not result in the impairment of recorded goodwill. In completing the analysis, the Company determined that it had two reporting units, which were the same as its reportable segments: (i) patient-care centers and (ii) distribution. As of June 30, 2002, the patient-care center segment had an unamortized balance of goodwill of $448.4 million. In accordance with SFAS No. 142, the effect of this accounting change is reflected prospectively. Supplemental comparative disclosure as if the change had been retroactively applied to the prior year period is as follows (in thousands, except per share amounts): 6 NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES (CONTINUED) Change in Accounting for Goodwill and Certain Other Intangibles (Continued)
Three Months Six Months Ended June 30, Ended June 30, ---------------------------- ------------------------------ 2002 2001 2002 2001 ---- ---- ---- ---- Net income (loss): Reported net income (loss) $ 7,671 $ (4,741) $ 9,193 $ (4,609) Goodwill amortization, net of tax benefit (1) - 2,570 - 1,590 ----------- ------------ ------------ ------------ Adjusted net income (loss) $ 7,671 $ (2,171) $ 9,193 $ (3,019) =========== ============ ============ ============ Per Share Info: Basic income (loss): Reported income (loss) $ 0.33 $ (0.31) $ 0.35 $ (0.37) Goodwill amortization, net of tax benefit (1) $ - $ 0.13 $ - $ 0.08 ----------- ------------ ------------ ------------ Adjusted basic income (loss) $ 0.33 $ (0.18) $ 0.35 $ (0.29) =========== ============ ============ ============ Diluted income (loss): Reported income (loss) $ 0.29 $ (0.31) $ 0.31 $ (0.37) Goodwill amortization, net of tax benefit (1) $ - $ 0.13 $ - $ 0.08 ----------- ------------ ------------ ------------ Adjusted diluted income (loss) $ 0.29 $ (0.18) $ 0.31 $ (0.29) =========== ============ ============ ============ (1) For the three ended June 30, 2001, consists of $3.3 million in amortization, offset by the reduction in the tax benefit of $0.7 million based on the revised effective tax rate for 2001. For the six months ended June 30, 2001, consists of $6.6 million in amortization, offset by the reduction in the tax benefit of $5.0 million based on the revised effective tax rate for 2001.
Amortization expense related to definite-lived intangible assets was $0.2 million and $0.5 million for the three and six months ended June 30, 2002, respectively. Estimated aggregate amortization expense for such assets for each of the five years ended December 31, 2006 is as follows (in thousands): 2002 $ 963 2003 $ 839 2004 $ 768 2005 $ 762 2006 $ 751 7 NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES (CONTINUED) New Accounting Pronouncements On April 30, 2002, the Financial Accounting Standard Board issued Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS 145"). Under SFAS 145, gains and losses from the early extinguishment of debt would no longer be extraordinary items, unless they satisfied the criteria in Accounting Principles Board Opinion No. 30 ("APB 30") where extraordinary items are stated to be distinguishable by their unusual nature and by the infrequency of their occurrence. Any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in APB 30 for classification as an extraordinary item shall be reclassified. In addition, under SFAS 145, certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. SFAS is effective for fiscal years beginning after May 15, 2002. SFAS 145 will be adopted by us on January 1, 2003 and may result in a reclassification of existing extraordinary losses on the early extinguishment of debt from an extraordinary item to a non-operating item. On July 30, 2002, the Financial Accounting Standard Board issued Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities ("SFAS 146"). Under SFAS 146, costs associated with exit or disposal activities would be recognized when they are incurred rather than at the date of a commitment to an exit or disposal plan. Such costs would include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. SFAS 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The Company does not expect SFAS 146 to have a material effect on its financial statements. NOTE C - SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION The following are the supplemental disclosure requirements for the statements of cash flows: 2002 2001 ---- ---- (in thousands) Cash paid during the period for: Interest $ 21,584 $ 27,518 Income taxes $ 916 $ 375 Non-cash financing and investing activities: Preferred stock dividends declared and accretion $ 2,557 $ 2,388 8 NOTE D - ACQUISITIONS The Company has not acquired any companies during the three or six months ended June 30, 2001 or 2002. In connection with the acquisition of NovaCare Orthotics & Prosthetics, Inc. ("NovaCare O&P") in July 1999, the Company assumed responsibility for payments of earnouts and working capital provisions related to acquisitions made by NovaCare O&P prior to July 1, 1999. In connection with these agreements and the Company's acquisitions prior to 2001, the Company paid $3.0 million and $2.8 million in the six-month periods ended June 30, 2002, and 2001, respectively. The Company has accounted for these amounts as additional purchase price, resulting in an increase in goodwill. The Company estimates that it may pay an additional $2.5 million related to earnout provisions that are expected to be paid by June 30, 2004. NOTE E - UNUSUAL CHARGES Summary Unusual charges for the three and six months ended June 30, 2001 consist of the following costs, which are explained below: Three Six (in thousands) Months Months ------ ------ Restructuring and asset impairment costs $3,688 $3,688 Performance improvement costs 1,460 2,975 Impairment loss on assets held for sale 8,176 8,176 ------- ------- Unusual charges $13,324 $14,839 ======= ======= Restructuring Costs In the second quarter of 2001, in connection with the implementation of the AlixPartners, LLC (formerly Jay Alix & Associates, Inc.; "JA&A") initiatives, the Company recorded approximately $3.7 million in restructuring and asset impairment costs. The plan of initiatives, as amended in December 2001, called for the closure of 44 facilities and the termination of approximately 135 employees. As of June 30, 2002, 42 properties had been vacated and 135 employees had been terminated. All payments under the plan for lease and severance costs are expected to be paid by December 31, 2004. The previously adopted 1999 and 2000 plans 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. All contemplated employees have been terminated and all contemplated patient-care centers have been closed. Lease payments on those closed patient-care centers are expected to be paid through 2003. 9 NOTE E - UNUSUAL CHARGES (CONTINUED) Restructuring Costs (Continued) Components of the restructuring reserves, spending during the periods, and remaining reserve balances are as follows:
Lease Employee Termination Total Severence and other Exit Restructuring Costs Costs Reserve ----- ----- ------- (in thousands) 1999 & 2000 Restructuring Reserve Balance at December 31, 2001 $ -- $ 329 $ 329 Spending -- (50) (50) ------- ------- ------- Balance at June 30, 2002 -- 279 279 ------- ------- ------- 2001 Restructuring Reserve Balance at December 31, 2001 50 1,886 1,936 Spending (30) (699) (729) ------- ------- ------- Balance at June 30, 2002 20 1,187 1,207 ------- ------- ------- 1999, 2000, and 2001 Restructuring Reserves Balance at June 30, 2002 $ 20 $ 1,466 $ 1,486 ======= ======= =======
Performance Improvement Costs Unusual charges for the three and six months ended June 30, 2001 amounted to $1.5 million and $3.0 million, respectively, in fees paid to JA&A in connection with the execution of the Company's performance improvement plan. JA&A's work with the Company was substantially completed as of December 31, 2001. In the fourth quarter of 2001, the Company was invoiced for and accrued a success fee based upon identified savings and operational improvements. The Company's contract with JA&A calls for the possibility of one additional success fee, which will be based on the realization of further savings from initiatives that were not fully implemented by December 31, 2001. As of June 30, 2002, these savings are not yet measurable, and therefore, the Company is unable to estimate the amount, if any, related to this second success fee. (See Note L.) 10 NOTE E - UNUSUAL CHARGES (CONTINUED) Impairment Loss on Assets Held for Sale During the three and six months ended June 30, 2001, the Company recognized an impairment loss of $8.2 million on the planned sale of substantially all of the manufacturing assets of Seattle Orthopedic Group, Inc. to United States Manufacturing Company, LLC ("USMC"). The amount of the loss represented the excess of the net book value of the assets held for sale over the estimated proceeds for the assets. The sale of the assets was ultimately completed on October 9, 2001. NOTE F - NET INCOME (LOSS) PER COMMON SHARE Basic per common share amounts are computed using the weighted average number of common shares outstanding during the period. Diluted per common share amounts are computed using the weighted average number of common shares outstanding during the period and dilutive potential common shares. Dilutive potential common shares consist of stock options, stock warrants, redeemable convertible preferred stock and convertible notes payable and are calculated using the treasury stock method. 11 NOTE F - NET INCOME (LOSS) PER COMMON SHARE (CONTINUED) Earnings per share for the three months ended June 30, 2002 and 2001 and for the six months ended June 30, 2002 and 2001 are computed based on the following amounts:
Three Months Six Months Ended June 30, Ended June 30, ------------------------------- ------------------------------- (in thousands, except share amounts) 2002 2001 2002 2001 ---- ---- ---- ---- Income (loss) before extraordinary item $ 7,671 $ (4,741) $ 12,004 $ (4,609) Less preferred stock dividends declared and accretion (1,291) (1,204) (2,557) (2,388) ------------ ------------ ------------ ------------ Income (loss) before extraordinary item available to common stockholders used to compute basic and diluted per common share amounts $ 6,380 $ (5,945) $ 9,447 $ (6,997) ============ ============ ============ ============ Net income (loss) $ 7,671 $ (4,741) $ 9,193 $ (4,609) Less preferred stock dividends declared and accretion (1,291) (1,204) (2,557) (2,388) ------------ ------------ ------------ ------------ Net income (loss) available to common stockholders used to compute basic and diluted per common share amounts $ 6,380 $ (5,945) $ 6,636 $ (6,997) ============ ============ ============ ============ Shares of common stock outstanding used to compute basic per common share amounts 19,336,954 18,910,002 19,221,865 18,910,002 Effect of dilutive options 2,452,016 -- 2,252,874 -- Effect of dilutive warrants 224,501 -- 194,441 -- ------------ ------------ ------------ ------------ Shares used to compute dilutive per common share amounts (1) 22,013,471 18,910,002 21,669,180 18,910,002 ============ ============ ============ ============ (1) Excludes the effect of the conversion of the 7% Redeemable Convertible Preferred Stock into Common Stock as it is considered anti-dilutive. For 2001, excludes the effect of all dilutive options and warrants as a result of the Company's net loss before extraordinary item available to common shareholders for the three and six months ended June 30, 2001.
NOTE G - INVENTORY Inventories at June 30, 2002 and December 31, 2001 consist of the following: June 30, December 31, (in thousands) 2002 2001 --------- --------- Raw materials $ 24,252 $ 27,224 Work in process 19,908 19,908 Finished goods 8,390 8,814 --------- --------- $ 52,550 $ 55,946 ========= ========= 12 NOTE H - LONG TERM DEBT Long-term debt consisted of the following at June 30, 2002 and December 31, 2001:
June 30, December 31, (in thousands) 2002 2001 ---- ---- Revolving Credit Facility $ 36,000 $ 74,800 10 3/8% Senior Notes due 2009 200,722 - A Term Loan Commitment - 63,995 B Term Loan Commitment - 89,592 11 1/4% Senior Subordinated Notes due 2009 150,000 150,000 Subordinated seller notes, non-collateralized net of unamortized discount of $0.1 million with principal and interest payable in either monthly, quarterly or annual installments at effective interest rates ranging from 6% to 12.287%, maturing through December 2011 13,820 19,440 ----------- ------------ 400,542 397,827 Less current portion (9,104) (30,512) ----------- ------------ $ 391,438 $ 367,315 =========== ============
On February 15, 2002, the Company sold $200.0 million principal amount of its 10 3/8% Senior Notes due 2009 (the "Senior Notes") and established a new $75.0 million senior secured revolving line of credit (the "Revolving Credit Facility"). The Senior Notes mature on February 15, 2009, are senior indebtedness and are guaranteed by all of the Company's domestic subsidiaries. Interest is payable semi-annually on February 15 and August 15, commencing August 15, 2002. The Revolving Credit Facility carries an interest rate of LIBOR plus 3.50% and matures on February 15, 2007. The Company used the $194.0 million net proceeds from the sale of the Senior Notes, along with approximately $36.5 million from the Revolving Credit Facility, to retire approximately $228.4 million of indebtedness, plus related fees and expenses, outstanding under the Company's previously existing revolving credit and term loan facilities. As a result of retiring the previously existing indebtedness, the Company wrote off $4.6 million in unamortized debt issuance costs that had previously been included in other assets. The extraordinary item for the six months ended June 30, 2002 consists of such costs, offset by a tax benefit of $1.8 million. 13 NOTE H - LONG TERM DEBT (CONTINUED) In March 2002, the Company entered into two fixed-to-floating interest rate swaps with an aggregate notional amount of $100.0 million in connection with the sale of the Senior Notes and in order to mitigate its interest rate risk. Under the interest rate swap agreements, the Company will receive amounts based on a fixed interest rate of 10 3/8% per annum. In return, the Company will pay amounts based on a variable interest rate based on the six-month LIBOR plus a spread between 492 and 497 basis points. The Company will receive and pay these amounts semiannually through the maturity date of February 15, 2009. The terms of these agreements are identical to the Senior Notes. The Company has designated its interest rate swaps as fair value hedges and they qualify for the short-cut method of accounting under the provisions of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities. The Company has adjusted the carrying amount of the Senior Notes and the swaps by $0.7 million, to reflect the fair value of the swaps as of June 30, 2002. The fair value of interest rate swaps are included in other assets. The Company uses derivative financial instruments for the purpose of hedging interest rate exposures that exist as part of ongoing business operations. The Company's derivative financial instruments are designated as and qualify as fair value flow hedges. The Company's policy requires that the Company formally document all relationships between hedging instruments and hedged items, as well as the Company's risk management objective and strategy for undertaking various hedge transactions. The Company also formally assesses (both at the hedge's inception and on an ongoing basis) whether the derivatives that are used in hedging transactions have been highly effective in offsetting changes in the fair value or of hedged items and whether those derivatives may be expected to remain highly effective in future periods. If it is determined that a derivative is not (or has ceased to be) highly effective as a hedge, the Company would discontinue hedge accounting prospectively. As a policy, the Company does not engage in speculative or leveraged transactions, nor does the Company hold or issue financial instruments for trading purposes. NOTE I - COMMITMENTS AND CONTINGENT LIABILITIES Commitments In October 2001, the Company entered into a Supply Agreement with USMC, under which it agreed to purchase certain products and components for use solely by the Company's patient-care centers during a five-year period following the date of the agreement. The Company is obligated to purchase from USMC at least $7.5 million of products and components during the first year following the date of the agreement, $8.5 million of products and components during the second year following the agreement, and $9.5 million of products and components during the third year following the date of the agreement, subject to certain adjustments. However, in the event purchases during each of the fourth and fifth years are less than approximately $8.7 million, the Company shall pay USMC an amount equal to $0.1 million multiplied by the number of $1.0 million units by which actual purchases during each of the fourth and fifth years are less than approximately $8.7 million. 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. 14 NOTE I - COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED) Contingencies (Continued) 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, the Company's Chairman of the Board and Chief Executive Officer of the Company, and Richard A. Stein, the Company's former Chief Financial Officer, Secretary and Treasurer. 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 have no merit and is vigorously defending the lawsuit. NOTE J - SEGMENT AND RELATED INFORMATION The Company has identified two reportable segments in which it operates based on the products and services it provides. The Company evaluates segment performance and allocates resources based on the segments' EBITDA. EBITDA is defined as net income (loss) before extraordinary item, interest, taxes, depreciation and amortization, and unusual charges consisting of impairment loss on assets held for sale, and integration, impairment, restructuring, and performance improvement costs. 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 health care companies. Moreover, substantially all of the Company's financing agreements contain covenants in which EBITDA is used as a measure of financial performance. Our definition of EBITDA may not be comparable to the definition of EBITDA used by other companies. Other EBITDA not directly attributable to reportable segments is primarily related to corporate general and administrative expenses. The two reportable segments are: (i) patient-care centers and (ii) distribution. A third segment that was previously reportable, manufacturing, was sold on October 9, 2001. On June 1, 2001, in anticipation of the sale of the manufacturing segment, the Company transferred its central fabrication operations from the manufacturing segment to the patient-care centers segment. Accordingly, all prior periods have been recast to be consistent with 2001 reporting. The reportable segments are described further below: 15 NOTE J - SEGMENT AND RELATED INFORMATION (CONTINUED) Patient-care centers - This segment consists of the Company's owned and operated O&P patient-care centers, fabrication centers of O&P components and OPNET. The patient-care centers provide services to design and fit orthotic and prosthetic devices to patients. These centers also instruct patients in the use, care and maintenance of the devices. Fabrication centers are involved in the fabrication of O&P components for both the O&P industry and the Company's own patient-care practices. OPNET is a national managed care agent for O&P services and a patient referral clearing house. Distribution - This segment distributes O&P products and components to both the O&P industry and the Company's own patient-care practices. Manufacturing - This previously reportable segment consisted of the manufacture of components and finished patient-care products for both the O&P industry and the Company's own patient-care practices. Summarized financial information concerning the Company's reportable segments is shown in the following table. Intersegment sales mainly include sales of O&P components from the manufacturing and distribution segments to the patient-care centers segment and were made at prices which approximate market values.
Patient-Care Other and Centers Distribution Manufacturing Eliminations Total ------- ------------ ------------- ------------ ----- (in thousands) Three Months Ended June 30, 2002 Net sales Customers $ 126,123 $ 6,933 $ - $ - $ 133,056 ================================================================================================ Intersegment $ - $ 12,796 $ - $ (12,796) $ - ================================================================================================ EBITDA $ 28,292 $ 1,864 $ - $ (4,980) $ 25,176 Depreciation and amortization 1,884 73 - 337 2,294 Interest expense, net 9,977 - - - 9,977 Provision for income taxes - - - 5,234 5,234 ------------------------------------------------------------------------------------------------ Net income (loss) $ 16,431 $ 1,791 $ - $ (10,551) $ 7,671 ================================================================================================ Three Months Ended June 30, 2001 Net sales Customers $ 119,988 $ 7,565 $ 1,634 $ - $ 129,187 ================================================================================================ Intersegment $ - $ 13,945 $ 1,149 $ (15,094) $ - ================================================================================================ EBITDA $ 26,503 $ 1,779 $ (20) $ (5,147) $ 23,115 Depreciation and amortization 5,346 110 438 513 6,407 Unusual charges 3,333 60 8,248 1,683 13,324 Interest expense, net 10,796 - 237 - 11,033 Benefit for income taxes - - - (2,908) (2,908) ------------------------------------------------------------------------------------------------ Net income (loss) $ 7,028 $ 1,609 $ (8,943) $ (4,435) $ (4,741) ================================================================================================
16 NOTE J - SEGMENT AND RELATED INFORMATION (CONTINUED)
Patient-Care Other and Centers Distribution Manufacturing Eliminations Total ------- ------------ ------------- ------------ ----- (in thousands) Six Months Ended June 30, 2002 ------------------------------ Net sales Customers $ 243,070 $ 13,496 $ - $ - $ 256,566 =============================================================================================== Intersegment $ - $ 25,195 $ - $ (25,195) $ - =============================================================================================== EBITDA $ 50,895 $ 3,008 $ - $ (9,531) $ 44,372 Depreciation and amortization 4,242 163 - 673 5,078 Interest expense, net 19,056 - - - 19,056 Provision for income taxes - - - 8,234 8,234 Extraordinary item - - - 2,811 2,811 ----------------------------------------------------------------------------------------------- Net income (loss) $ 27,597 $ 2,845 $ - $ (21,249) $ 9,193 =============================================================================================== Six Months Ended June 30, 2001 ------------------------------ Net sales Customers $ 231,034 $ 15,512 $ 3,214 $ - $ 249,760 =============================================================================================== Intersegment $ - $ 26,720 $ 2,239 $ (28,959) $ - =============================================================================================== EBITDA $ 45,628 $ 3,364 $ 224 $ (11,191) $ 38,025 Depreciation and amortization 10,623 219 854 815 12,511 Unusual charges 4,051 89 8,260 2,439 14,839 Interest expense, net 23,037 - 254 - 23,291 Benefit for income taxes - - - (8,007) (8,007) ----------------------------------------------------------------------------------------------- Net income (loss) $ 7,917 $ 3,056 $ (9,144) $ (6,438) $ (4,609) ===============================================================================================
NOTE K - CONSOLIDATING FINANCIAL INFORMATION The Company's Senior Notes, Senior Subordinated Notes and Revolving Credit Facility are guaranteed fully, jointly and severally, and unconditionally by all of the Company's current and future domestic subsidiaries. The following is summarized condensed consolidating financial information, as of June 30, 2002 and December 31, 2001, for the three-month periods ended June 30, 2002 and 2001, and for the six-month periods ended June 30, 2002 and 2001 of the Company, segregating the parent company (Hanger Orthopedic Group, Inc.) and its guarantor subsidiaries, as each of the Company's subsidiaries is wholly-owned. 17 NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger Orthopedic Group (Parent Guarantor Consolidating Consolidated BALANCE SHEET - June 30, 2002 Company) Subsidiaries Adjustments Totals ----------------------------- -------- ------------ ----------- ------ (in thousands) ASSETS Cash and cash equivalents $ 6,570 $ 8,631 $ - $ 15,201 Accounts receivable - 105,995 - 105,995 Inventories - 52,550 - 52,550 Prepaid expenses and other assets 26,987 2,854 (24,402) 5,439 Intercompany receivable 93,785 (93,785) - - Deferred income taxes 20,957 - - 20,957 ---------------------------------------------------------------- Total current assets 148,299 76,245 (24,402) 200,142 Property, plant and equipment, net 4,387 30,690 - 35,077 Intangible assets, net (156) 454,812 - 454,656 Investment in subsidiaries 85,239 - (85,239) - Other assets 422,369 2,852 (406,700) 18,521 ---------------------------------------------------------------- Total assets $ 660,138 $ 564,599 $(516,341) $ 708,396 ================================================================ LIABILITIES, REDEEMABLE PREFERRED STOCK, AND SHAREHOLDERS' EQUITY Current portion of long-term debt $ - $ 9,104 $ - $ 9,104 Accounts payable 7 7,381 - 7,388 Accrued expenses 3,231 6,228 - 9,459 Accrued interest payable 7,536 24,777 (24,402) 7,911 Accrued compensation related cost 2,062 20,615 - 22,677 Income taxes payable 6,428 (2,016) - 4,412 ---------------------------------------------------------------- Total current liabilities 19,264 66,089 (24,402) 60,951 Long-term debt, less current portion 386,722 411,416 (406,700) 391,438 Deferred income taxes 26,495 - - 26,495 Other liabilities - 1,855 - 1,855 ---------------------------------------------------------------- Total liabilities 432,481 479,360 (431,102) 480,739 ---------------------------------------------------------------- Redeemable preferred stock 73,296 - - 73,296 ---------------------------------------------------------------- Common stock 195 35 (35) 195 Additional paid-in capital 148,721 7,461 (7,461) 148,721 Retained earnings 6,101 78,283 (78,283) 6,101 Treasury stock (656) (540) 540 (656) ---------------------------------------------------------------- Total shareholders' equity 154,361 85,239 (85,239) 154,361 ---------------------------------------------------------------- Total liabilities, redeemable preferred stock, and shareholders' equity ---------------------------------------------------------------- $ 660,138 $ 564,599 $(516,341) $ 708,396 ================================================================
18 NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONSOLIDATED)
Hanger Orthopedic Group (Parent Guarantor Consolidating Consolidated BALANCE SHEET - December 31, 2001 Company) Subsidiaries Adjustments Totals --------------------------------- -------- ------------ ----------- ------ (in thousands) ASSETS Cash and cash equivalents $ (212) $ 10,255 $ - $ 10,043 Accounts receivable - 104,040 - 104,040 Inventories - 55,946 - 55,946 Prepaid expenses and other assets 591 4,310 - 4,901 Intercompany receivable 126,124 (126,124) - - Deferred income taxes 20,957 - - 20,957 ---------------------------------------------------------------- Total current assets 147,460 48,427 - 195,887 Property, plant and equipment, net 4,767 33,011 - 37,778 Intangible assets, net (156) 452,536 - 452,380 Investment in subsidiaries 60,673 - (60,673) - Other assets 417,672 2,890 (406,700) 13,862 ---------------------------------------------------------------- Total assets $ 630,416 $ 536,864 $(467,373) $ 699,907 ================================================================ LIABILITIES, REDEEMABLE PREFERRED STOCK, AND SHAREHOLDERS' EQUITY Current portion of long-term debt $ 19,199 $ 11,313 $ - $ 30,512 Accounts payable 520 16,381 - 16,901 Accrued expenses 4,586 3,610 - 8,196 Accrued interest payable 1,577 440 - 2,017 Accrued compensation related cost 2,438 26,607 - 29,045 ---------------------------------------------------------------- Total current liabilities 28,320 58,351 - 86,671 Long-term debt, less current portion 359,188 414,827 (406,700) 367,315 Deferred income taxes 26,495 - - 26,495 Other liabilities - 3,013 - 3,013 ---------------------------------------------------------------- Total liabilities 414,003 476,191 (406,700) 483,494 ---------------------------------------------------------------- Redeemable preferred stock 70,739 - - 70,739 ---------------------------------------------------------------- Common stock 191 35 (35) 191 Additional paid-in capital 146,674 7,461 (7,461) 146,674 Accumulated deficit (535) 53,717 (53,717) (535) Treasury stock (656) (540) 540 (656) ---------------------------------------------------------------- Total shareholders' equity 145,674 60,673 (60,673) 145,674 ---------------------------------------------------------------- Total liabilities, redeemable preferred stock, and shareholders' equity ---------------------------------------------------------------- $ 630,416 $ 536,864 $(467,373) $ 699,907 ================================================================
19 NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger Orthopedic Group (Parent Guarantor Consolidating Consolidated STATEMENTS OF OPERATIONS Company) Subsidiaries Adjustments Totals ------------------------ -------- ------------ ----------- ------ (in thousands) Three months ended June 30, 2002 Net sales $ - $ 145,852 $ (12,796) $ 133,056 Cost of goods sold - 74,090 (12,792) 61,298 ---------------------------------------------------------------- Gross profit - 71,762 (4) 71,758 Selling, general and administrative 4,980 41,606 (4) 46,582 Depreciation and amortization 337 1,957 - 2,294 ---------------------------------------------------------------- Income (loss) from operations (5,317) 28,199 - 22,882 Interest income (expense), net 2,481 (12,458) - (9,977) Equity in earnings of subsidiaries 15,741 - (15,741) - ---------------------------------------------------------------- Income (loss) before taxes 12,905 15,741 (15,741) 12,905 Provision for income taxes 5,234 - - 5,234 ---------------------------------------------------------------- Net income (loss) $ 7,671 $ 15,741 $ (15,741) $ 7,671 ================================================================ Three months ended June 30, 2001 Net sales $ - $ 144,281 $ (15,094) $ 129,187 Cost of goods sold - 78,528 (15,094) 63,434 ---------------------------------------------------------------- Gross profit - 65,753 - 65,753 Selling, general and administrative 5,147 37,491 - 42,638 Depreciation and amortization 513 2,602 - 3,115 Amortization of excess cost over net assets acquired - 3,292 - 3,292 Unusual charges 1,683 11,641 - 13,324 ---------------------------------------------------------------- Income (loss) from operations (7,343) 10,727 - 3,384 Interest income (expense), net 1,836 (12,869) (11,033) Equity in earnings of subsidiaries (2,142) - 2,142 - ---------------------------------------------------------------- Income (loss) before taxes (7,649) (2,142) 2,142 (7,649) Benefit for income taxes (2,908) - - (2,908) ---------------------------------------------------------------- Net income (loss) $ (4,741) $ (2,142) $ 2,142 $ (4,741) ================================================================
20 NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger Orthopedic Group (Parent Guarantor Consolidating Consolidated STATEMENTS OF OPERATIONS Company) Subsidiaries Adjustments Totals ------------------------ -------- ------------ ----------- ------ (in thousands) Six months ended June 30, 2002 Net sales $ - $ 281,761 $ (25,195) $ 256,566 Cost of goods sold - 146,021 (25,186) 120,835 ---------------------------------------------------------------- Gross profit - 135,740 (9) 135,731 Selling, general and administrative 9,533 81,835 (9) 91,359 Depreciation and amortization 672 4,406 - 5,078 ---------------------------------------------------------------- Income (loss) from operations (10,205) 49,499 - 39,294 Interest income (expense), net 5,877 (24,933) - (19,056) Equity in earnings of subsidiaries 24,566 - (24,566) - ---------------------------------------------------------------- Income (loss) before taxes 20,238 24,566 (24,566) 20,238 Provision for income taxes 8,234 - - 8,234 ---------------------------------------------------------------- Income (loss) before extraordinary item 12,004 24,566 (24,566) 12,004 Extraordinary item (2,811) - - (2,811) ---------------------------------------------------------------- Net income (loss) $ 9,193 $ 24,566 $ (24,566) $ 9,193 ================================================================ Six months ended June 30, 2001 Net sales $ - $ 278,729 $ (28,969) $ 249,760 Cost of goods sold - 155,377 (28,969) 126,408 ---------------------------------------------------------------- Gross profit - 123,352 - 123,352 Selling, general and administrative 11,191 74,136 - 85,327 Depreciation and amortization 817 5,137 - 5,954 Amortization of excess cost over net assets acquired - 6,557 - 6,557 Unusual charges 2,439 12,400 - 14,839 ---------------------------------------------------------------- Income (loss) from operations (14,447) 25,122 - 10,675 Interest income (expense), net 2,305 (25,596) - (23,291) Equity in earnings of subsidiaries (474) - 474 - ---------------------------------------------------------------- Income (loss) before taxes (12,616) (474) 474 (12,616) Provision for income taxes (8,007) - - (8,007) ---------------------------------------------------------------- Net income (loss) $ (4,609) $ (474) $ 474 $ (4,609) ================================================================
21 NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger Orthopedic Group (Parent Guarantor Consolidating Consolidated STATEMENTS OF CASH FLOWS Company) Subsidiaries Adjustments Totals ------------------------ -------- ------------ ----------- ------ Six months ended June 30, 2002 Cash flows provided by operating activities $ 6,885 $ 9,111 $ - $ 15,996 Cash flows used in investing activities (280) (5,116) - (5,396) Cash flows provided by (used in) financing activities 177 (5,619) - (5,442) ---------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 6,782 (1,624) - 5,158 Cash and cash equivalents, beginning of period (212) 10,255 - 10,043 ---------------------------------------------------------------- Cash and cash equivalents, end of period $ 6,570 $ 8,631 $ - $ 15,201 ================================================================ Six months ended June 30, 2001 Cash flows provided by operating activities $ 2,759 $ 9,973 $ - $ 12,732 Cash flows used in investing activities (762) (5,278) - (6,040) Cash flows used in financing activities (10,309) (6,969) - (17,278) ---------------------------------------------------------------- Net decrease in cash and cash equivalents (8,312) (2,274) - (10,586) Cash and cash equivalents, beginning of period 10,829 9,840 - 20,669 ---------------------------------------------------------------- Cash and cash equivalents, end of period $ 2,517 $ 7,566 $ - $ 10,083 ================================================================
NOTE L - SUBSEQUENT EVENT As described in Note E, the Company approved for payment two invoices for success fees in the fourth quarter of 2001. In accordance with the contract with JA&A, the invoices were satisfied by the payment of $1.1 million in cash and the issuance of nonqualified options to purchase 1,202,436 shares of the Company's stock at an exercise price of $1.40 per share. The options were valued using a Black-Scholes option-pricing model, and an expense of $4.8 million was recorded. On July 23, 2002 the Company agreed to purchase 601,218 of the options previously granted for a payment of $3.98 per share, or a total of $2,392,704. On July 23, 2002 the Company's shares opened for trading at $12.00 per share. The Company also agreed to file a Registration Statement on Form S-3 with the Securities and Exchange Commission within 20 business days to register the remaining 601,218 shares underlying this option in order to permit JA&A to sell the shares of the Company's stock that it may acquire upon exercise of the option. 22 NOTE L - SUBSEQUENT EVENT (CONTINUED) In connection with the sale of any shares that JA&A may acquire under these options JA&A has agreed to limit sales of shares of the Company's stock to 40,000 shares in any calendar week. JA&A also agreed to permanently amend its contract with the Company so that the payment of future success fees, if any, would be made only in cash. Completion of the transaction with JA&A is subject to the approval, which the Company expects to obtain, of a majority of the banks holding the Revolving Credit Facility. 23 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 Six Months Ended June 30, Ended June 30, -------------- -------------- 2002 2001 2002 2001 ---- ---- ---- ---- Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of goods sold 46.1 49.1 47.1 50.6 Gross profit 53.9 50.9 52.9 49.4 Selling, general and administrative 35.0 33.0 35.6 34.2 Depreciation and amortization 1.7 2.4 2.0 2.4 Amortization of excess cost over net assets acquired - 2.5 - 2.6 Unusual charges - 10.4 - 5.9 Income from operations 17.2 2.6 15.3 4.3 Interest expense, net 7.5 8.5 7.4 9.3 Income (loss) before taxes 9.7 (5.9) 7.9 (5.1) Provision (benefit) for income taxes 3.9 (2.2) 3.2 (3.2) Net income (loss) before extraordinary item 5.8 (3.7) 4.7 (1.8) Extraordinary item - - (1.1) - Net income (loss) 5.8 (3.7) 3.6 (1.8)
Three Months Ended June 30, 2002 Compared to the Three Months Ended June 30, 2001 Net Sales. Net sales for the quarter ended June 30, 2002, were $133.1 million, an increase of $3.9 million, or 3.0%, versus net sales of $129.2 million for the quarter ended June 30, 2001. The sales growth was primarily the result of a 5.2% increase in same center sales in the Company's O&P patient-care practices offset by a $0.6 million, or 0.5%, decrease in outside sales of the distribution segment and a $1.6 million, or 1.2%, reduction in sales due to the sale of Seattle Orthopedic Group, Inc. ("SOGI"), the Company's manufacturing segment, in the fourth quarter of 2001. Gross Profit. Gross profit in the quarter ended June 30, 2002 was $71.8 million, an increase of $6.0 million, or 9.1%, versus $65.8 million for the quarter ended June 30, 2001. Gross profit as a percentage of net sales increased to 53.9% in the second quarter of 2002 versus 50.9% in the second quarter of 2001. The improvement in gross profit, in both dollars and as a percentage of sales, was due to a reduction in labor and material costs as well as the increase in net sales. 24 Selling, General and Administrative. Selling, general and administrative expenses in the quarter ended June 30, 2002 increased by $3.9 million, or 9.2%, compared to the quarter ended June 30, 2001. Selling, general and administrative expenses as a percentage of net sales increased to 35.0% in the second quarter of 2002 compared to 33.0% for same period in 2001. The increase in selling, general and administrative expenses in both dollars and as a percentage of sales was primarily due to an increase in our accrual for the practitioners' performance-based bonus program costs that resulted from the Company's increased collections and decreased labor and material costs. Depreciation and Amortization. Depreciation and amortization for the three months ended June 30, 2002 were $2.3 million, a 64.2% decrease in such costs versus the $6.4 million for the three months ended June 30, 2001. The decrease is due principally to the discontinuation of amortization related to goodwill commencing January 1, 2002 pursuant to Statement of Financial Accounting Standards No. 142 and to the sale of SOGI in the fourth quarter of 2001. Unusual Charges. Unusual charges for the three months ended June 30, 2001 amounted to $13.3 million, which consisted of the following one-time costs: (i) restructuring charges of $3.6 million principally related to severance and lease termination expenses; (ii) an $8.2 million loss on the disposal of substantially all the manufacturing assets of SOGI; and (iii) $1.5 million in other charges primarily related to fees paid to AlixPartners, LLC (formerly Jay Alix & Associates, Inc.; "JA&A") in connection with development of the Company's performance improvement plan. No such unusual charges were incurred during the three months ended June 30, 2002. JA&A's work with the Company was substantially completed as of December 31, 2001. In the fourth quarter of 2001, we were invoiced for and accrued a success fee based upon identified savings and operational improvements. Our contract with JA&A calls for the possibility of one additional success fee, which will be based on the realization of further savings from initiatives that were not fully implemented by December 31, 2001. As of June 30, 2002, these savings are not yet measurable, and therefore, we are unable to estimate the amount, if any, related to this second success fee. Income from Operations. Principally as a result of the above, income from operations for the quarter ended June 30, 2002 was $22.9 million, an increase of $19.5 million, or 576.2%, compared to the quarter ended June 30, 2001. Income from operations as a percentage of net sales increased by 14.6 percentage points to 17.2% of net sales in the second quarter of 2002 versus 2.6% for the prior year's comparable period. Interest Expense, Net. Interest expense in the second quarter of 2002 was $10.0 million, a decrease of $1.0 million from the $11.0 million incurred in the second quarter of 2001. The decrease in dollars of interest expense was primarily attributable to a decrease in average borrowings and a reduction in LIBOR. Income Taxes. The provision for income taxes for the three months ended June 30, 2002 was $5.2 million compared to a benefit from income taxes of $2.9 million for the three months ended June 30, 2001. The change in the income tax provision was due to the Company's return to profitability and the impact of the discontinuation of amortization related to goodwill. 25 Net Income (Loss). As a result of the above, we recorded net income of $7.7 million for the three months ended June 30, 2002, compared to net loss of $4.7 million in the comparable quarter in the prior year, an improvement of $12.4 million. Six Months Ended June 30, 2002 Compared to the Six Months Ended June 30, 2001 Net Sales. Net sales for the six months ended June 30, 2002, were $256.6 million, an increase of $6.8 million, or 2.7%, versus net sales of $249.8 million for the six months ended June 30, 2001. The sales growth was primarily the result of a 5.3% increase in same center sales in the Company's O&P patient-care practices offset by a $2.0 million, or 0.8%, decrease in outside sales of the distribution segment and a $3.2 million, or 1.3%, reduction in sales due to the sale of SOGI, the Company's manufacturing segment, in the fourth quarter of 2001. Gross Profit. Gross profit in the six months ended June 30, 2002 was $135.7 million, an increase of $12.4 million, or 10.0%, versus $123.4 million for the six months ended June 30, 2001. Gross profit as a percentage of net sales increased to 52.9% in the first six months of 2002 versus 49.4% in the first six months of 2001. The improvement in gross profit, in both dollars and as a percentage of sales, was due to a reduction in labor and material costs as well as the increase in net sales. Selling, General and Administrative. Selling, general and administrative expenses in the six months ended June 30, 2002 increased by $6.0 million, or 7.1%, compared to the six months ended June 30, 2001. Selling, general and administrative expenses as a percentage of net sales increased to 35.6% in the first six months of 2002 compared to 34.2% for the same period in 2001. The increase in selling, general and administrative expenses in both dollars and as a percentage of sales was primarily due to an increase in our accrual for the practitioners' performance-based bonus program of approximately $7.0 million that resulted from the Company's increased collections and decreased labor and material costs, offset by decreases in legal and occupancy costs of approximately $1.0 million. Depreciation and Amortization. Depreciation and amortization for the six months ended June 30, 2002 were $5.1 million, a 59.4% decrease in such costs versus the $12.5 million for the six months ended June 30, 2001. The decrease is due principally to the discontinuation of amortization related to goodwill commencing January 1, 2002 pursuant to Statement of Financial Accounting Standards No. 142 and to the sale of SOGI in the fourth quarter of 2001. Unusual Charges. Unusual charges for the six months ended June 30, 2001 amounted to $14.8 million, which consisted of the following one-time costs: (i) restructuring charges of $3.6 million principally related to severance and lease termination expenses; (ii) an $8.2 million loss on the disposal of substantially all the manufacturing assets of SOGI; and (iii) $3.0 million in other charges primarily related to fees paid to JA&A in connection with development of the Company's performance improvement plan. No such unusual charges were incurred during the six months ended June 30, 2002. 26 Income from Operations. Principally as a result of the above, income from operations for the six months ended June 30, 2002 was $39.3 million, an increase of $28.6 million, or 268.1%, compared to the six months ended June 30, 2001. Income from operations as a percentage of net sales increased by 11.0 percentage points to 15.3% of net sales in the first six months of 2002 versus 4.3% for the prior year's comparable period. Interest Expense, Net. Interest expense in the first six months of 2002 was $19.1 million, a decrease of $4.2 million from the $23.3 million incurred in the first six months of 2001. The decrease in dollars of interest expense was primarily attributable to a decrease in average borrowings and a reduction in LIBOR. Income Taxes. The provision for income taxes for the six months ended June 30, 2002 was $8.2 million compared to a benefit from income taxes of $8.0 million for the six months ended June 30, 2001. The change in the income tax provision was due to the Company's return to profitability. Net Income (Loss) before Extraordinary Item. As a result of the above, we recorded net income before extraordinary item of $12.0 million for the six months ended June 30, 2002, compared to a net loss before extraordinary item of $4.6 million in the comparable period in the prior year, an improvement of $16.6 million. Extraordinary Item. The extraordinary item of $2.8 million ($4.6 million pre-tax) in the six months ended June 30, 2002, represents the write-off of debt issue costs as a result of extinguishing $228.4 million of bank debt in connection with the issuance of the $200.0 million principal amount of its 10 3/8% Senior Notes due 2009 (the "Senior Notes") and the establishment of the $75.0 million senior secured revolving line of credit (the "Revolving Credit Facility"). Net Income (Loss). As a result of the above, we recorded net income of $9.2 million for the six months ended June 30, 2002, compared to net loss of $4.6 million in the comparable period in the prior year, an improvement of $13.8 million and the impact of the discontinuation of amortization related to goodwill. Financial Condition, Liquidity And Capital Resources Our working capital at June 30, 2002 was $139.2 million compared to $109.2 million at December 31, 2001. Our cash and cash equivalents amounted to $15.2 million at June 30, 2002 and $10.0 million at December 31, 2001. The current ratio improved to 3.3 to 1 at June 30, 2002, compared to 2.3 to 1 at December 31, 2001. Available cash under our Revolving Credit Facility increased to $39.0 million at June 30, 2002 compared to $25.2 million at December 31, 2001. Net cash provided by operating activities for the six months ended June 30, 2002 was $16.0 million, compared to $12.7 million provided by operating activities in the six months ended June 30, 2001. The $3.3 million increase was primarily due to the increase in the Company's EBITDA, which is defined as net income (loss) before extraordinary item, interest, taxes, depreciation and amortization, and unusual charges. 27 Net cash used in investing activities was $5.4 million for the six months ended June 30, 2002, versus $6.0 million for the same period in the prior year. The decrease in net cash used was primarily due to the receipt of proceeds from the sale of the building which formerly housed the Company's distribution segment. Net cash used in financing activities was $5.4 million for the six months ended June 30, 2002. During that period, the Company received $200.0 million in proceeds from the sale of the Senior Notes that were offset by (i) principal payments of $153.6 million to retire our Tranche A & B Term Facilities, (ii) a net paydown of $38.3 million of our revolving line of credit, and (iii) payment of $8.1 million in financing costs related to the issuance of the Senior Notes and the establishment of the Revolving Credit Facility. In addition, during that period, the Company received $2.1 million in proceeds from the exercise of stock options, offset by: (i) scheduled principal payments of $5.6 million on our long-term debt, (ii) a net paydown of $0.5 million of our revolving line of credit and (iii) payment of $1.4 million in financing costs related to the issuance of the Senior Notes and the establishment of the Revolving Credit Facility. On February 15, 2002, we issued $200.0 million aggregate principal amount of Senior Notes in a private placement exempt from registration under the Securities Act of 1933, as amended. We also established, concurrent with the sale of the Senior Notes, the Revolving Credit Facility. The Senior Notes mature on February 15, 2009 and do not require any prepayments of principal prior to maturity. Interest on the Senior Notes accrues from February 15, 2002, and is payable semi-annually on February 15 and August 15 of each year, commencing August 15, 2002. Payment of principal and interest on the Senior Notes is guaranteed on a senior unsecured basis by all of our current and future domestic subsidiaries. The indenture limits our ability to, among other things, incur additional indebtedness, create liens, pay dividends on or redeem capital stock, make certain investments, make restricted payments, make certain dispositions of assets, engage in transactions with affiliates, engage in certain business activities and engage in mergers, consolidations and certain sales of assets. On May 13, 2002, we commenced an exchange offer to exchange the privately-placed, unregistered Senior Notes with new Senior Notes that had been registered under the Securities Act of 1933, as amended, on the Company's Registration Statement on Form S-4 filed with the Securities and Exchange Commission. The exchange offer expired on June 11, 2002. All of the previously issued unregistered Senior Notes were exchanged for registered Senior Notes. The new notes are substantially identical to the previously issued notes except that the new notes will be free of the transfer restrictions that applied to unregistered notes. The Revolving Credit Facility, which was provided by a syndicate of banks and other financial institutions, is a senior secured revolving credit facility providing for loans of up to $75.0 million and will terminate on February 15, 2007. Borrowings under the Revolving Credit Facility will bear interest, at our option, at an annual rate equal to LIBOR plus 3.50% or the Base Rate (as defined in the Revolving Credit Facility) plus 2.50% in each case, subject to adjustments based on financial performance. Our obligations under the Revolving Credit Facility are guaranteed by our subsidiaries and are secured by a first priority perfected security interest in our subsidiaries' 28 shares, all of our assets and all of the assets of our subsidiaries. Borrowings under the Revolving Credit Facility are prepayable at any time without premium or penalty. The Revolving Credit Facility requires compliance with various financial covenants, including a minimum consolidated interest coverage ratio, minimum consolidated EBITDA, a maximum total leverage ratio, a maximum senior secured leverage ratio and a minimum fixed charge coverage ratio, as well as other covenants. The Revolving Credit Facility contains customary events of default and is subject to various mandatory prepayments and commitment reductions During the fourth quarter of 2001, the Company approved for payment two invoices from JA&A for success fees. In accordance with the contract with JA&A, the invoices were satisfied by the payment of $1.1 million in cash and the issuance of nonqualified options to purchase 1,202,436 shares of the Company's stock at an exercise price of $1.40 per share. The options were valued using a Black-Scholes option-pricing model, and an expense of $4.8 million was recorded. On July 23, 2002 the Company agreed to purchase 601,218 of the options previously granted for a payment of $3.98 per share, or a total of $2,392,704. On July 23, 2002 the Company's shares opened for trading at $12.00 per share. The Company also agreed to file a Registration Statement on Form S-3 with the Securities and Exchange Commission within 20 business days to register the remaining 601,218 shares underlying this option in order to permit JA&A to sell the shares of the Company's stock that it may acquire upon exercise of the option. In connection with the sale of any shares that JA&A may acquire under these options JA&A has agreed to limit sales of shares of the Company's stock that it may acquire by exercise of the options, to 40,000 shares in any calendar week. JA&A also agreed to permanently amend its contract with the Company so that the payment of future success fees, if any, would be made only in cash. Completion of the transaction with JA&A is subject to the approval, which the Company expects to obtain, of a majority of the banks holding the Revolving Credit Facility. We believe that, based on current levels of operations and anticipated growth, cash generated from operations, together with other available sources of liquidity, including borrowings available under the Revolving Credit Facility, will be sufficient for the foreseeable future to fund anticipated capital expenditures and make required payments of principal and interest on our debt, including payments due on the Senior Notes and obligations under the Revolving Credit Facility. In addition, we continually evaluate potential acquisitions and expect to fund such acquisitions from our available sources of liquidity, as discussed above. Market Risk We are exposed to the market risk that is associated with changes in interest rates. To manage that risk, in March 2002, we entered into interest rate swaps to modify our exposure to interest rate movements and reduce borrowing costs. We entered into $100.0 million fixed-to-floating interest rate swaps, consisting of floating rate instruments benchmarked to LIBOR. We are exposed to potential losses in the event of nonperformance by the counterparties to the swap agreements. 29 New Accounting Pronouncements On April 30, 2002, the Financial Accounting Standard Board issued Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS 145"). Under SFAS 145, gains and losses from the early extinguishment of debt would no longer be extraordinary items, unless they satisfied the criteria in Accounting Principles Board Opinion No. 30 ("APB 30") where extraordinary items are stated to be distinguishable by their unusual nature and by the infrequency of their occurrence. Any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in APB 30 for classification as an extraordinary item shall be reclassified. In addition, under SFAS 145, certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. SFAS is effective for fiscal years beginning after May 15, 2002. SFAS 145 will be adopted by us on January 1, 2003 and may result in a reclassification of existing extraordinary losses on the early extinguishment of debt from an extraordinary item to a non-operating item. On July 30, 2002, the Financial Accounting Standard Board issued Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities ("SFAS 146"). Under SFAS 146, costs associated with exit or disposal activities would be recognized when they are incurred rather than at the date of a commitment to an exit or disposal plan. Such costs would include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. SFAS 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The Company does not expect SFAS 146 to have a material effect on its financial statements. Critical Accounting Estimates The Company's analysis and discussion of its financial condition and results of operations are based upon its consolidated financial statements that have been prepared in accordance with generally accepted accounting principles in the United States ("U.S. GAAP"). The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. U.S. GAAP provides the framework from which to make these estimates, assumptions and disclosures. The Company chooses accounting policies within U.S. GAAP that management believes are appropriate to accurately and fairly report the Company's operating results and financial position in a consistent manner. Management regularly assesses these policies in light of current and forecasted economic conditions. The Company's accounting principles are stated in Note B to the Consolidated Financial Statements as presented in the Company's Annual Report on Form 10-K for the year ended December 31, 2001. In connection with the adoption of SFAS No. 142; Goodwill and Other Intangible Assets, the Company believes the following accounting policy is critical to understanding the results of operations and affect the more significant judgments and estimates used in the preparation of the consolidated financial statements. 30 o Intangible Assets: Excess cost over net assets acquired represents the excess of purchase price over the value assigned to net identifiable assets of purchased businesses. Other definite-lived intangible assets include non-compete agreements which are recorded based on agreements entered into by the Company and are amortized over their estimated useful lives ranging from 5 to 7 years using the straight-line method. The remainder of the other definite-lived intangible assets, including patents, are recorded at cost and are amortized over their estimated useful lives of up to 16 years using the straight-line method. SFAS 142 requires that excess cost over net assets acquired and indefinite-lived intangibles be tested for impairment annually. In connection with the impairment assessment management reviews and assesses, future cash flows, the market value of the Company's stock price as well as other market valuation indicators. Further changes in these items could result in an impairment. Impairment would be recognized by a charge to operating results and a reduction in the carrying value of the asset. Class Action 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 us 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, our Chairman of the Board, President and Chief Executive Officer, and Richard A. Stein, our former Chief Financial Officer, Secretary and Treasurer. 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 have no merit and is vigorously defending the lawsuit. Other Inflation has not had a significant effect on the Company's operations, as increased costs to the Company 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. 31 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, federal laws governing the health-care industry, 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 publicly update these forward-looking statements, whether as a result of new information, future events or otherwise. 32 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk In the normal course of business, we are exposed to fluctuations in interest rates. We address this risk by using interest rate swaps from time to time. At December 31, 2001 there were no interest rate swaps outstanding. In March 2002, the Company entered into two fixed-to-floating interest rate swaps with an aggregate notional amount of $100 million, as discussed in Note H to Hanger's Consolidated Financial Statements. 33 PART II. OTHER INFORMATION ITEM 4. Submission of Matters to a Vote of Security Holders The Company's Annual Meeting of Stockholders was held on May 30, 2002. The first proposal was the election of directors. The following persons were nominated and elected to serve as members of the Board of Directors for one year or until their successors are elected and qualified by the votes indicated: Mitchell J. Blutt, M.D. (16,055,242 shares for and 1,844,092 shares withheld), Edmond E. Charrette, M.D. (16,569,957 shares for and 1,329,377 shares withheld), Thomas P. Cooper, M.D. (16,571,777 shares for and 1,327,577 shares withheld), Robert J. Glaser, M.D. (16,568,175 shares for and 1,331,159 shares withheld), Eric Green (16,570,057 shares for and 1,329,277 shares withheld), C. Raymond Larkin, Jr. (16,570,964 shares for and 1,328,370 shares withheld), Risa J. Lavizzo-Mourey, M.D. (16,571,684 shares for and 1,327,650 shares withheld), Ivan R. Sabel (16,572,864 shares for and 1,326,470 shares withheld) and H.E. Thranhardt (16,572,184 shares for and 1,327,150 shares withheld). The second proposal was the proposed approval of the Company's 2002 Stock Option Plan and authorization of 1,500,000 shares of the Company's Common Stock for issuance under that Plan. The proposal was approved by the holders of more than the required majority of the shares of Common Stock voting at the meeting. The proposal was approved by a vote of 10,471,851 shares of Common Stock for (representing approximately 58.5% of the shares voting), 1,817,639 shares of Common Stock against, with 91,868 shares of Common Stock abstaining and 6,902,979 shares of Common Stock not voting on this proposal. The third proposal was the proposed ratification of the selection of PricewaterhouseCoopers LLP as the independent accountants for the Company for the current fiscal year. The proposal was approved by the holders of more than the required majority of the shares of Common Stock voting at the meeting. The proposal was approved by a vote of 17,831,202 shares for (representing approximately 99.6% of the shares voting), 39,014 shares against, with 8,032 shares abstaining and 1,406,001 shares of Common Stock not voting on this proposal. 34 ITEM 6. Exhibits and Reports on Form 8-K Exhibits and Reports on Form 8-K (a) Exhibits. The following exhibits are filed herewith: Exhibit No. Document 99.1 Written Statement of the Chief Executive Officer Pursuant to 18 U.S.C.ss.1350 (Attached herewith.) 99.2 Written Statement of the Chief Financial Officer Pursuant to 18 U.S.C.ss.1350 (Attached herewith.) (b) Forms 8-K. None 35 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. Dated: August 14, 2002 /s/ Ivan R. Sabel ------------------------------------ Ivan R. Sabel, CPO Chairman and Chief Executive Officer (Principal Executive Officer) Dated: August 14, 2002 /s/ George E. McHenry ------------------------------------ George E. McHenry Chief Financial Officer (Principal Financial Officer) Dated: August 14, 2002 /s/ Glenn M. Lohrmann ------------------------------------ Glenn M. Lohrmann Controller (Chief Accounting Officer) 36