10-Q 1 slp442.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, 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 November 12, 2002; 20,240,398 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, 2002 (unaudited) and December 31, 2001 1 Consolidated Statements of Operations for the three and nine months ended September 30, 2002 and 2001 (unaudited) 3 Consolidated Statements of Cash Flows for the nine months ended September 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 26 Item 3. Quantitative and Qualitative Disclosures About Market Risk 35 Item 4. Controls and Procedures 36 Part II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 37 SIGNATURES 38 CERTIFICATIONS 39 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except share and per share amounts)
September 30, December 31, 2002 2001 -------------- ------------- (unaudited) ASSETS CURRENT ASSETS Cash and cash equivalents $ 22,002 $ 10,043 Accounts receivable, less allowances for doubtful accounts of $16,057 and $17,625 in 2002 and 2001, respectively 104,994 104,040 Inventories 54,526 55,946 Prepaid, other assets, and income taxes receivable 5,070 4,901 Deferred income taxes 20,957 20,957 -------- -------- Total current assets 207,549 195,887 -------- -------- PROPERTY, PLANT AND EQUIPMENT Land 3,743 4,078 Buildings 6,700 8,629 Machinery and equipment 33,409 28,675 Furniture and fixtures 10,259 9,967 Leasehold improvements 18,002 18,027 -------- -------- 72,113 69,376 Less accumulated depreciation and amortization 36,932 31,598 -------- -------- 35,181 37,778 -------- -------- INTANGIBLE ASSETS Excess cost over net assets acquired 450,745 440,874 Assembled workforce -- 4,812 Patents and other intangible assets, $10,134 and $10,124 less accumulated amortization of $4,162 and $3,430 in 2002 and 2001, respectively 5,972 6,694 -------- -------- 456,717 452,380 -------- -------- OTHER ASSETS Debt issuance costs, net 14,316 10,846 Other assets 10,062 3,016 -------- -------- Total other assets 24,378 13,862 -------- -------- TOTAL ASSETS $723,825 $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)
September 30, December 31, 2002 2001 --------------- -------------- (unaudited) LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Current portion of long-term debt $ 6,888 $ 30,512 Accounts payable 9,827 16,901 Accrued expenses 9,475 8,196 Accrued interest payable 7,679 2,017 Accrued compensation related cost 33,798 29,045 Accrued income taxes 6,890 -- --------- --------- Total current liabilities 74,557 86,671 Long-term debt, less current portion 386,934 367,315 Deferred income taxes 26,495 26,495 Other liabilities 1,729 3,013 --------- --------- Total liabilities 489,715 483,494 --------- --------- 7% Redeemable Convertible Preferred stock, liquidation preference $1,000 per share 74,607 70,739 --------- --------- Commitments and contingent liabilities (See Note I) SHAREHOLDERS' EQUITY Common stock, $.01 par value; 60,000,000 shares authorized, 19,742,163 and 19,057,876 shares issued and outstanding in 2002 and 2001, respectively 197 191 Additional paid-in capital 147,342 146,674 Retained earnings (accumulated deficit) 12,620 (535) --------- --------- 160,159 146,330 Treasury stock, cost -- (133,495 shares) (656) (656) --------- --------- 159,503 145,674 --------- --------- TOTAL LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY $ 723,825 $ 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 Nine Months Ended September 30, (Dollars in thousands, except share and per share amounts)
Three Months Ended Nine Months Ended September 30, September 30, 2002 2001 2002 2001 ------------ ------------ ------------ ------------ (unaudited) (unaudited) Net sales $ 133,980 $ 129,605 $ 390,546 $ 379,365 Cost of goods sold (exclusive of depreciation and amortization) 59,971 61,606 180,806 188,014 ------------ ------------ ------------ ------------ Gross profit 74,009 67,999 209,740 191,351 Selling, general and administrative 48,541 45,791 139,900 131,118 Depreciation and amortization 2,400 3,091 7,478 9,045 Amortization of excess cost over net assets acquired -- 3,306 -- 9,863 Unusual charges -- 1,381 -- 16,220 ------------ ------------ ------------ ------------ Income from operations 23,068 14,430 62,362 25,105 Interest expense, net 9,870 10,768 28,926 34,059 ------------ ------------ ------------ ------------ Income (loss) before taxes 13,198 3,662 33,436 (8,954) Provision (benefit) for income taxes 5,368 3,679 13,602 (4,328) ------------ ------------ ------------ ------------ Income (loss) before extraordinary item 7,830 (17) 19,834 (4,626) Extraordinary loss on early extinguishment of debt, net of tax benefit -- -- 2,811 -- ------------ ------------ ------------ ------------ Net income (loss) $ 7,830 $ (17) $ 17,023 $ (4,626) ============ ============ ============ ============ Income (loss) before extraordinary item applicable to common stock $ 6,519 $ (1,242) $ 15,966 $ (8,239) ============ ============ ============ ============ Net income (loss) applicable to common stock $ 6,519 $ (1,242) $ 13,155 $ (8,239) ============ ============ ============ ============ Basic Per Common Share Data Income (loss) before extraordinary item $ 0.33 $ (0.07) $ 0.82 $ (0.44) Extraordinary item, net of tax benefit -- -- (0.14) -- ------------ ------------ ------------ ------------ Net income (loss) $ 0.33 $ (0.07) $ 0.68 $ (0.44) ============ ============ ============ ============ Shares used to compute basic per common share amounts 19,554,942 18,910,002 19,353,827 18,910,002 ============ ============ ============ ============ Diluted Per Common Share Data Income (loss) before extraordinary item $ 0.30 $ (0.07) $ 0.74 $ (0.44) Extraordinary item, net of tax benefit -- -- (0.13) -- ------------ ------------ ------------ ------------ Net income (loss) $ 0.30 $ (0.07) $ 0.61 $ (0.44) ============ ============ ============ ============ Shares used to compute diluted per common share amounts 21,913,967 18,910,002 21,502,115 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 Nine Months Ended September 30, (Dollars in thousands)
2002 2001 ------------ ----------- Cash flows from operating activities: (unaudited) Net income (loss) $ 17,023 $ (4,626) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Extraordinary loss on extinguishment of debt 2,811 -- Loss on disposal of assets 998 8,029 Provision for bad debts 16,333 16,143 Depreciation and amortization 7,478 9,046 Amortization of excess cost over net assets acquired -- 9,862 Amortization of debt issuance costs 1,700 1,931 Deferred income taxes -- 191 Restructuring costs -- 3,688 Changes in assets and liabilities: Accounts receivable (17,288) (16,785) Inventories 1,421 8,733 Prepaid, other assets, and income taxes receivable (1,201) 1,188 Other assets (191) 375 Accounts payable (7,910) (6,773) Accrued expenses, interest and income taxes 16,682 (8,404) Accrued compensation related costs 4,753 4,383 Other liabilities (1,287) 1,685 --------- --------- Net cash provided by operating activities 41,322 28,666 --------- --------- Cash flows from investing activities: Purchase of property, plant and equipment (6,638) (4,902) Acquisitions, net of cash acquired, and earnouts (4,230) (4,732) Proceeds from sale of property, plant and equipment 1,492 634 --------- --------- Net cash used in investing activities (9,376) (9,000) --------- --------- Cash flows from financing activities: Borrowings under revolving credit agreement 43,975 4,000 Repayments under revolving credit agreement (92,775) (10,900) Proceeds from sale of Senior Notes 200,000 -- Repayment and termination of bank loans (153,587) (18,500) Scheduled repayment of long-term debt (8,474) (10,416) Increase in financing costs (9,800) (1,060) Proceeds from issuance of Common Stock 3,067 -- Repurchase of outstanding stock options (2,393) -- --------- --------- Net cash used in financing activities (19,987) (36,876) --------- --------- Increase (decrease) in cash and cash equivalents 11,959 (17,210) Cash and cash equivalents at beginning of period 10,043 20,669 --------- --------- Cash and cash equivalents at end of period $ 22,002 $ 3,459 ========= =========
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 (consisting solely of normal recurring adjustments) 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 on 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. 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, screened 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. The Company has chosen October 1, 2002 as the date of its next impairment test and will report the results of that test in the fourth quarter. As of September 30, 2002, the patient-care center segment had goodwill of $450.7 million, an increase of $5.1 million over December 31, 2001. 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 Ended Nine Months Ended September 30, September 30, 2002 2001 2002 2001 Net income (loss): Reported net income (loss) $ 7,830 $ (17) $ 17,023 $ (4,626) Goodwill amortization, net of tax benefit (1) -- 2,950 -- 5,009 ----------- --------- ---------- ---------- Adjusted net income (loss) $ 7,830 $ 2,933 $ 17,023 $ 383 =========== ========= ========== ========== Per share info: Basic income (loss): Reported income (loss) $ 0.33 $ (0.07) $ 0.68 $ (0.44) Goodwill amortization, net of tax benefit (1) $ -- $ 0.16 $ -- $ 0.27 ----------- --------- ---------- ---------- Adjusted basic income (loss) $ 0.33 $ 0.09 $ 0.68 $ (0.17) =========== ========= ========== ========== Diluted income (loss): Reported income (loss) $ 0.30 $ (0.07) $ 0.61 $ (0.44) Goodwill amortization, net of tax benefit (1) $ -- $ 0.16 $ -- $ 0.27 ----------- --------- ---------- ---------- Adjusted diluted income (loss) $ 0.30 $ 0.09 $ 0.61 $ (0.17) =========== ========= ========== ==========
(1) For the three months ended September 30, 2001, consists of $3.3 million in amortization and a reduction in the tax expense of $0.3 million based on the revised effective tax rate for 2001. For the nine months ended September 30, 2001, consists of $9.9 million in amortization, offset by the reduction in the tax benefit of $4.9 million based on the revised effective tax rate for 2001. Amortization includes amortization related to assembled workforce, which was combined with goodwill at January 1, 2002. Amortization expense related to definite-lived intangible assets was $0.2 million and $0.7 million for the three and nine months ended September 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 No. 145"). Under SFAS No. 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 No. 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 No. 145 is effective for fiscal years beginning after May 15, 2002. SFAS No. 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 No. 146"). Under SFAS No. 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 No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The Company does not expect SFAS No. 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 $ 31,465 $ 34,113 Income taxes $ 3,809 $ 976 Non-cash financing and investing activities: Preferred stock dividends declared and accretion $ 3,868 $ 3,613 8 NOTE D - ACQUISITIONS The Company has not acquired any companies during the three or nine months ended September 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 $4.2 million and $4.7 million in the nine-month periods ended September 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 $1.4 million related to earnout provisions that are expected to be paid by December 31, 2005. NOTE E - UNUSUAL CHARGES Summary Unusual charges for the three and nine months ended September 30, 2001 consist of the following costs, which are explained below: Three Nine (in thousands) Months Months Restructuring and asset impairment costs $ - $ 3,688 Performance improvement costs 1,528 4,503 Impairment loss on assets held for sale (147) 8,029 ----------- ----------- Unusual charges $ 1,381 $ 16,220 =========== =========== 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 September 30, 2002, all contemplated properties had been vacated and all contemplated employees had been terminated. All payments under the plan for severance costs have been paid as of September 30, 2002 and all payments for lease costs are expected to be paid by December 31, 2004. 9 NOTE E - UNUSUAL CHARGES (CONTINUED) Restructuring Costs (Continued) 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. Components of the restructuring reserves, spending during the periods, and remaining reserve balances are as follows:
Lease Employee Termination Total Severance and other Exit Restructuring Costs Costs Reserve ---------------------------------------------------------------------------------------- (in thousands) 1999 & 2000 Restructuring Reserve Balance at December 31, 2001 $ -- $ 329 $ 329 Spending -- (56) (56) ------- ------- ------- Balance at September 30, 2002 -- 273 273 ------- ------- ------- 2001 Restructuring Reserve Balance at December 31, 2001 50 1,886 1,936 Spending (50) (919) (969) ------- ------- ------- Balance at September 30, 2002 -- 967 967 ------- ------- ------- 1999, 2000, and 2001 Restructuring Reserves Balance at September 30, 2002 $ -- $ 1,240 $ 1,240 ======= ======= =======
Performance Improvement Costs Performance improvement costs for the three and nine months ended September 30, 2001 amounted to $1.5 million and $4.5 million, respectively, consisting primarily of 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. In accordance with our contract with JA&A, the invoices were satisfied by the payment of $1.1 million in cash and the issuance of a nonqualified option to purchase 1,202,436 shares of the Company's stock at an exercise price of $1.40 per share. The option was valued using a Black-Scholes option-pricing model, and an expense of $4.8 million was recorded. 10 NOTE E - UNUSUAL CHARGES (CONTINUED) Performance Improvement Costs (Continued) On July 23, 2002, the Company agreed to repurchase 601,218 of the shares underlying such previously granted option for a payment of $3.98 per share, or a total of $2,392,704, which was paid during the third quarter of 2002 and recorded as a reduction in additional paid-in capital. On July 23, 2002, shares of the Company's common stock opened for trading at $12.00 per share. In accordance with our agreement with JA&A, the Company filed a Registration Statement on Form S-3 with the Securities and Exchange Commission to register the remaining 601,218 shares underlying the outstanding 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. Under the agreement with the Company on July 23, 2002, in accordance with the sale of any shares that JA&A may acquire by exercise of the option, JA&A has agreed to limit such sales to 40,000 shares in any calendar week. The Company's original contract with JA&A provides for one potential additional success fee, which will be based on the realization of further savings from initiatives that were not fully implemented by December 31, 2001. Under the agreement with the Company on July 23, 2002, 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. As of September 30, 2002, JA&A has measured all savings generated and the Company believes that no further payments will be required under the contract. Impairment Loss on Assets Held for Sale During the nine months ended September 30, 2001, the Company recognized an impairment loss of $8.0 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 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 September 30, 2002 and 2001 and for the nine months ended September 30, 2002 and 2001 are computed based on the following amounts:
Three Months Ended Nine Months Ended September 30, September 30, ------------- ------------- (in thousands, except share amounts) 2002 2001 2002 2001 ---- ---- ---- ---- Income (loss) before extraordinary item $ 7,830 $ (17) $ 19,834 $ (4,626) Less preferred stock dividends declared and accretion (1,311) (1,225) (3,868) (3,613) ------------ ------------ ------------ ------------ Income (loss) before extraordinary item available to common stockholders used to compute basic and diluted per common share amounts $ 6,519 $ (1,242) $ 15,966 $ (8,239) ============ ============ ============ ============ Net income (loss) $ 7,830 $ (17) $ 17,023 $ (4,626) Less preferred stock dividends declared and accretion (1,311) (1,225) (3,868) (3,613) ------------ ------------ ------------ ------------ Net income (loss) available to common stockholders used to compute basic and diluted per common share amounts $ 6,519 $ (1,242) $ 13,155 $ (8,239) ============ ============ ============ ============ Shares of common stock outstanding used to compute basic per common share amounts 19,554,942 18,910,002 19,353,827 18,910,002 Effect of dilutive options 2,120,226 -- 1,935,846 -- Effect of dilutive warrants 238,799 -- 212,442 -- ------------ ------------ ------------ ------------ Shares used to compute dilutive per common share amounts (1) 21,913,967 18,910,002 21,502,115 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 nine months ended September 30, 2001. Options, outstanding at September 30, 2002, to purchase 280,500 and 1,006,313 shares of common stock are not included in the computation of diluted income per share for the three and nine months ended September 30, 2002, respectively, as these options are anti-dilutive. Options and warrants to purchase 4,252,460 and 830,650 shares, respectively, of common stock were outstanding at September 30, 2001 and are not included in the computation of diluted income per share for the three and nine months ended September 30, 2001 due to the Company's net loss during these periods. 12 NOTE G - INVENTORY Inventories at September 30, 2002 and December 31, 2001 consist of the following: September 30, December 31, (in thousands) 2002 2001 -------------- ---- ---- Raw materials $25,174 $27,224 Work in process 19,908 19,908 Finished goods 9,444 8,814 ------- ------- $54,526 $55,946 ======= ======= NOTE H - LONG TERM DEBT Long-term debt consisted of the following at September 30, 2002 and December 31, 2001:
September 30, December 31, (in thousands) 2002 2001 -------------- ---- ---- Revolving Credit Facility $ 26,000 $ 74,800 10 3/8% Senior Notes due 2009 206,856 -- 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 10,966 19,440 --------- --------- 393,822 397,827 Less current portion (6,888) (30,512) --------- --------- $ 386,934 $ 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. 13 NOTE H - LONG TERM DEBT (CONTINUED) 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. As of September 30, 2002, the Company was in compliance with these covenants. The Company assesses, on a quarterly basis, its compliance with these covenants and monitors any matters critical to continue its compliance. 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 nine months ended September 30, 2002 consists of such costs, offset by a tax benefit of $1.8 million. 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 $6.9 million to reflect the fair value of the swaps as of September 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. 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. 14 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 satisfied its obligation to purchase from USMC at least $7.5 million of products and components during the first year following the date of the agreement. Accordingly, on November 1, 2002, the escrow agent released $1.0 million in escrowed funds to the Company for the satisfaction of such first-year purchase obligations. In addition, the Company is obligated to purchase from USMC at least $8.5 million and $9.5 million of products and components during the second and third years following the agreement, respectively, 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. 15 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 (and then President), and Richard A. Stein, the Company's former Chief Financial Officer, Secretary and Treasurer (the "Class Action Lawsuit"). 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 Class Action Lawsuit has been dismissed by the District Court for failure to comply with statutory requirements. On November 5, 2002, plaintiffs filed a notice of appeal to the United States Court of Appeals for the Fourth Circuit. The Company believes that the allegations have no merit and is vigorously defending the Class Action 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, as used by management to evaluate segment performance, 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. 16 NOTE J - SEGMENT AND RELATED INFORMATION (CONTINUED) 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: 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. 17 NOTE J - SEGMENT AND RELATED INFORMATION (CONTINUED)
Patient-Care Other and Centers Distribution Manufacturing Eliminations Total ------- ------------ ------------- ------------ ----- (in thousands) Three Months Ended September 30, 2002 Net sales Customers $ 126,006 $ 7,974 $ - $ - $ 133,980 ================================================================================= Intersegment $ - $ 13,723 $ - $ (13,723) $ - ================================================================================= EBITDA $ 25,854 $ 3,121 $ - $ (3,507) $ 25,468 Depreciation and amortization 1,994 72 - 334 2,400 Interest expense, net 9,870 - - - 9,870 Provision for income taxes - - - 5,368 5,368 --------------------------------------------------------------------------------- Net income (loss) $ 13,990 $ 3,049 $ - $ (9,209) $ 7,830 ================================================================================= Three Months Ended September 30, 2001 Net sales Customers $ 120,893 $ 7,177 $ 1,535 $ - $ 129,605 ================================================================================= Intersegment $ - $ 13,598 $ 1,323 $ (14,921) $ - ================================================================================= EBITDA $ 25,891 $ 1,367 $ (415) $ (4,635) $ 22,208 Depreciation and amortization 5,315 116 438 528 6,397 Unusual charges 244 101 (142) 1,178 1,381 Interest expense, net 12,590 - 16 (1,838) 10,768 Provision for income taxes - - - 3,679 3,679 --------------------------------------------------------------------------------- Net income (loss) $ 7,742 $ 1,150 $ (727) $ (8,182) $ (17) ================================================================================= Nine Months Ended September 30, 2002 Net sales Customers $ 369,076 $ 21,470 $ - $ - $ 390,546 ================================================================================ Intersegment $ - $ 38,918 $ - $ (38,918) $ - ================================================================================= EBITDA $ 76,751 $ 6,129 $ - $ (13,040) $ 69,840 Depreciation and amortization 6,236 235 - 1,007 7,478 Interest expense, net 28,926 - - - 28,926 Provision for income taxes - - - 13,602 13,602 Extraordinary item - - - 2,811 2,811 --------------------------------------------------------------------------------- Net income (loss) $ 41,589 $ 5,894 $ - $ (30,460) $ 17,023 ================================================================================= Nine Months Ended September 30, 2001 Net sales Customers $ 351,927 $ 22,689 $ 4,749 $ - $ 379,365 ================================================================================= Intersegment $ - $ 40,318 $ 3,562 $ (43,880) $ - ================================================================================= EBITDA $ 71,519 $ 4,731 $ (191) $ (15,826) $ 60,233 Depreciation and amortization 15,938 335 1,292 1,343 18,908 Unusual charges 4,295 190 8,118 3,617 16,220 Interest expense, net 35,627 - 270 (1,838) 34,059 Benefit for income taxes - - - (4,328) (4,328) --------------------------------------------------------------------------------- Net income (loss) $ 15,659 $ 4,206 $ (9,871) $ (14,620) $ (4,626) =================================================================================
18 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 September 30, 2002 and December 31, 2001, for the three-month periods ended September 30, 2002 and 2001, and for the nine-month periods ended September 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. 19 NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger Orthopedic Group (Parent Guarantor Consolidating Consolidated BALANCE SHEET - September 30, 2002 Company) Subsidiaries Adjustments Totals ---------------------------------- -------- ------------ ----------- ------ (in thousands) ------------------------------------------------------------------ ASSETS Cash and cash equivalents $ 14,028 $ 7,974 $ - $ 22,002 Accounts receivable - 104,994 - 104,994 Inventories - 54,526 - 54,526 Prepaid expenses and other assets (1) 38,241 3,432 (36,603) 5,070 Intercompany receivable 59,734 (59,734) - - Deferred income taxes 20,957 - - 20,957 ----------------------------------------------------------------- Total current assets 132,960 111,192 (36,603) 207,549 Property, plant and equipment, net 4,838 30,343 - 35,181 Intangible assets, net (154) 456,871 - 456,717 Investment in subsidiaries 99,831 - (99,831) - Other assets (1) 428,214 2,864 (406,700) 24,378 ---------------------------------------------------------------- Total assets $ 665,689 $ 601,270 $(543,134) $ 723,825 ================================================================ LIABILITIES, REDEEMABLE PREFERRED STOCK, AND SHAREHOLDERS' EQUITY Current portion of long-term debt $ - $ 6,888 $ - $ 6,888 Accounts payable 4 9,823 - 9,827 Accrued expenses 3,912 5,563 - 9,475 Accrued interest payable (1) 7,335 36,947 (36,603) 7,679 Accrued compensation related cost 1,518 32,280 - 33,798 Income taxes payable 9,419 (2,529) - 6,890 ---------------------------------------------------------------- Total current liabilities 22,188 88,972 (36,603) 74,557 Long-term debt, less current portion (1) 382,856 410,778 (406,700) 386,934 Deferred income taxes 26,495 - - 26,495 Other liabilities 40 1,689 - 1,729 ---------------------------------------------------------------- Total liabilities 431,579 501,439 (443,303) 489,715 ---------------------------------------------------------------- Redeemable preferred stock 74,607 - - 74,607 ---------------------------------------------------------------- Common stock 197 35 (35) 197 Additional paid-in capital 147,343 7,461 (7,461) 147,343 Retained earnings 12,619 92,875 (92,875) 12,619 Treasury stock (656) (540) 540 (656) ---------------------------------------------------------------- Total shareholders' equity 159,503 99,831 (99,831) 159,503 ---------------------------------------------------------------- Total liabilities, redeemable preferred stock, and shareholders' equity $ 665,689 $ 601,270 $ (543,134) $ 723,825 ================================================================
(1) Other assets of the parent company and long-term debt of the guarantor subsidiaries include a $406.7 million note payable from a subsidiary to the parent. At September 30, 2002, prepaid expenses and other assets of the parent company and accrued interest payable of the guarantor subsidiaries include $36.6 million in interest accrued under the note payable. 20 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 (1) 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 (1) 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 ===============================================================
(1) Other assets of the parent company and long-term debt of the guarantor subsidiaries include a $406.7 million note payable from a subsidiary to the parent. 21 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 September 30, 2002 Net sales $ - $ 147,703 $ (13,723) $ 133,980 Cost of goods sold (exclusive of depreciation and amortization) - 73,692 (13,721) 59,971 --------------------------------------------------------------- Gross profit - 74,011 (2) 74,009 Selling, general and administrative 3,507 45,036 (2) 48,541 Depreciation and amortization 334 2,066 - 2,400 --------------------------------------------------------------- Income (loss) from operations (3,841) 26,909 - 23,068 Interest income (expense), net 2,447 (12,317) - (9,870) Equity in earnings of subsidiaries 14,592 - (14,592) - --------------------------------------------------------------- Income (loss) before taxes 13,198 14,592 (14,592) 13,198 Provision for income taxes 5,368 - - 5,368 --------------------------------------------------------------- Net income (loss) $ 7,830 $ 14,592 $ (14,592) $ 7,830 =============================================================== Three months ended September 30, 2001 Net sales $ - $ 144,526 $ (14,921) $ 129,605 Cost of goods sold (exclusive of depreciation and amortization) - 76,527 (14,921) 61,606 --------------------------------------------------------------- Gross profit - 67,999 - 67,999 Selling, general and administrative 4,635 41,156 - 45,791 Depreciation and amortization 528 2,563 - 3,091 Amortization of excess cost over net assets acquired - 3,306 - 3,306 Unusual charges 1,178 203 - 1,381 --------------------------------------------------------------- Income (loss) from operations (6,341) 20,771 - 14,430 Interest income (expense), net 1,838 (12,606) (10,768) Equity in earnings of subsidiaries 8,165 - (8,165) - --------------------------------------------------------------- Income (loss) before taxes 3,662 8,165 (8,165) 3,662 Provision for income taxes 3,679 - - 3,679 --------------------------------------------------------------- Net income (loss) $ (17) $ 8,165 $ (8,165) $ (17) ===============================================================
22 NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger Orthopedic Group (Parent Guarantor Consolidating Consolidated STATEMENTS OF OPERATIONS Company) Subsidiaries Adjustments Totals ------------------------ -------- ------------ ----------- ------ (in thousands) ----------------------------------------------------------------- Nine months ended September 30, 2002 Net sales $ - $ 429,464 $ (38,918) $ 390,546 Cost of goods sold (exclusive of depreciation and amortization) - 219,713 (38,907) 180,806 ---------------------------------------------------------------- Gross profit - 209,751 (11) 209,740 Selling, general and administrative 13,040 126,871 (11) 139,900 Depreciation and amortization 1,007 6,471 - 7,478 ---------------------------------------------------------------- Income (loss) from operations (14,047) 76,409 - 62,362 Interest income (expense), net 8,325 (37,251) - (28,926) Equity in earnings of subsidiaries 39,158 - (39,158) - ---------------------------------------------------------------- Income (loss) before taxes 33,436 39,158 (39,158) 33,436 Provision for income taxes 13,602 - - 13,602 ---------------------------------------------------------------- Income (loss) before extraordinary item 19,834 39,158 (39,158) 19,834 Extraordinary item (2,811) - - (2,811) ---------------------------------------------------------------- Net income (loss) $ 17,023 $ 39,158 $ (39,158) $ 17,023 ================================================================ Nine months ended September 30, 2001 Net sales $ - $ 423,255 $ (43,890) $ 379,365 Cost of goods sold (exclusive of depreciation and amortization) - 231,904 (43,890) 188,014 ---------------------------------------------------------------- Gross profit - 191,351 - 191,351 Selling, general and administrative 15,826 115,292 - 131,118 Depreciation and amortization 1,343 7,702 - 9,045 Amortization of excess cost over net assets acquired - 9,863 - 9,863 Unusual charges 3,617 12,603 - 16,220 ---------------------------------------------------------------- Income (loss) from operations (20,786) 45,891 - 25,105 Interest income (expense), net 4,143 (38,202) - (34,059) Equity in earnings of subsidiaries 7,689 - (7,689) - ---------------------------------------------------------------- Income (loss) before taxes (8,954) 7,689 (7,689) (8,954) Benefit for income taxes (4,328) - - (4,328) ---------------------------------------------------------------- Net income (loss) $ (4,626) $ 7,689 $ (7,689) $ (4,626) ================================================================
23 NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger Orthopedic Group (Parent Guarantor Consolidating Consolidated STATEMENTS OF CASH FLOWS Company) Subsidiaries Adjustments Totals ------------------------ -------- ------------ ----------- ------ (in thousands) ----------------------------------------------------------------- Nine months ended September 30, 2002 Cash flows from operating activities: Net cash provided by operating activities $ 26,927 $ 14,395 $ - $ 41,322 --------------------------------------------------------------- Cash flows from investing activities: Purchase of property, plant and equipment (1,174) (5,464) - (6,638) Acquisitions, net of cash acquired, and earnouts - (4,230) - (4,230) Proceeds from sale of property, plant and equipment - 1,492 - 1,492 --------------------------------------------------------------- Net cash used in investing activities (1,174) (8,202) - (9,376) --------------------------------------------------------------- Cash flows from financing activities: Borrowings under revolving credit agreement 43,975 - - 43,975 Repayments under revolving credit agreement (92,775) - - (92,775) Proceeds from sale of Senior Notes 200,000 - - 200,000 Repayment and termination of bank loans (153,587) - - (153,587) Scheduled repayment of long-term debt - (8,474) - (8,474) Increase in financing costs (9,800) - - (9,800) Proceeds from issuance of Common Stock 3,067 - - 3,067 Repurchase of outstanding stock options (2,393) - - (2,393) --------------------------------------------------------------- Net cash used in financing activities (11,513) (8,474) - (19,987) --------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 14,240 (2,281) - 11,959 Cash and cash equivalents, beginning of period (212) 10,255 - 10,043 --------------------------------------------------------------- Cash and cash equivalents, end of period $ 14,028 $ 7,974 $ - $ 22,002 ===============================================================
24 NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger Orthopedic Group (Parent Guarantor Consolidating Consolidated STATEMENTS OF CASH FLOWS Company) Subsidiaries Adjustments Totals ------------------------ -------- ------------ ----------- ------ (in thousands) ----------------------------------------------------------------- Nine months ended September 30, 2001 Cash flows from operating activities: Net cash provided by operating activities $ 7,282 $ 21,384 $ - $ 28,666 ---------------------------------------------------------------- Cash flows from investing activities: Purchase of property, plant and equipment (1,028) (3,874) - (4,902) Acquisitions, net of cash acquired, and earnouts - (4,732) - (4,732) Proceeds from sale of property, plant and equipment - 634 - 634 ---------------------------------------------------------------- Net cash used in investing activities (1,028) (7,972) - (9,000) ---------------------------------------------------------------- Cash flows from financing activities: Borrowings under revolving credit agreement 4,000 - - 4,000 Repayments under revolving credit agreement (10,900) - - (10,900) Proceeds from sale of Senior Notes - - - - Repayment and termination of bank loans (18,500) - - (18,500) Scheduled repayment of long-term debt - (10,416) - (10,416) Increase in financing costs (1,060) - - (1,060) Proceeds from issuance of Common Stock - - - - Repurchase of outstanding stock options - - - - ---------------------------------------------------------------- Net cash used in financing activities (26,460) (10,416) - (36,876) ---------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (20,206) 2,996 - (17,210) Cash and cash equivalents, beginning of period 10,829 9,840 - 20,669 ---------------------------------------------------------------- Cash and cash equivalents, end of period $ (9,377) $ 12,836 $ - $ 3,459 ================================================================
25 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 Ended Nine Months Ended September 30, September 30, ------------- ------------- 2002 2001 2002 2001 ---- ---- ---- ---- Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of goods sold 44.8 47.5 46.3 49.6 Gross profit 55.2 52.5 53.7 50.4 Selling, general and administrative 36.2 35.3 35.8 34.5 Depreciation and amortization 1.8 2.4 1.9 2.4 Amortization of excess cost over net assets acquired - 2.6 - 2.6 Unusual charges - 1.1 - 4.2 Income from operations 17.2 11.1 16.0 6.7 Interest expense, net 7.4 8.3 7.4 9.0 Income (loss) before taxes 9.8 2.8 8.6 (2.3) Provision (benefit) for income taxes 4.0 2.8 3.5 (1.1) Net income (loss) before extraordinary item 5.8 - 5.1 (1.2) Extraordinary item - - 0.7 - Net income (loss) 5.8 - 4.4 (1.2)
Three Months Ended September 30, 2002 Compared to the Three Months Ended September 30, 2001 Net Sales. Net sales for the quarter ended September 30, 2002, were $134.0 million, an increase of $4.4 million, or 3.4%, versus net sales of $129.6 million for the quarter ended September 30, 2001. The sales growth was primarily the result of a 4.6% increase in same center sales in the Company's O&P patient-care practices and a $0.8 million, or 0.6%, increase in outside sales of the distribution segment offset by a $1.5 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 September 30, 2002 was $74.0 million, an increase of $6.0 million, or 8.8%, versus $68.0 million for the quarter ended September 30, 2001. Gross profit as a percentage of net sales increased to 55.2% in the third quarter of 2002 versus 52.5% in the third quarter of 2001. Specifically, the gross profit, as a percentage of sales, for the patient-care segment increased to 55.3% in the third quarter of 2002 versus 53.5% in the third quarter of 2001; similarly, the gross profit, as a percentage of sales, for the distribution segment 26 increased to 20.2% in the third quarter of 2002 versus 13.0% in the third 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. Selling, General and Administrative. Selling, general and administrative expenses in the quarter ended September 30, 2002 increased by $2.8 million, or 6.0%, compared to the quarter ended September 30, 2001. Selling, general and administrative expenses as a percentage of net sales increased to 36.2% in the third quarter of 2002 compared to 35.3% 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 a $2.3 million 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 September 30, 2002 were $2.4 million, a 62.5% decrease in such costs versus the $6.4 million for the three months ended September 30, 2001. The decrease was due principally to the discontinuation of amortization related to goodwill commencing January 1, 2002 pursuant to SFAS No. 142, which had been $3.3 million during the third quarter of 2001, and also to the sale of SOGI in the fourth quarter of 2001. Unusual Charges. Unusual charges for the three months ended September 30, 2001 amounted to $1.4 million in 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. 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 provides for one potential 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 September 30, 2002, JA&A has measured all savings generated and the Company believes that no further payments will be required under the contract. Income from Operations. Principally as a result of the above, income from operations for the quarter ended September 30, 2002 was $23.1 million, an increase of $8.6 million, or 60.0%, compared to the quarter ended September 30, 2001. Income from operations as a percentage of net sales increased by 6.1 percentage points to 17.2% of net sales in the third quarter of 2002 versus 11.1% for the prior year's comparable period. Interest Expense, Net. Interest expense in the third quarter of 2002 was $9.9 million, a decrease of $0.9 million from the $10.8 million incurred in the third quarter of 2001. The decrease in 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 September 30, 2002 was $5.4 million compared to $3.7 million for the three months ended September 30, 2001. The change in the income tax provision was due to the Company's increased profitability. 27 Net Income (Loss). As a result of the above, we recorded net income of $7.8 million for the three months ended September 30, 2002, compared to a small loss in the comparable quarter in the prior year, an improvement of $7.8 million. Nine months Ended September 30, 2002 Compared to the Nine months Ended September 30, 2001 Net Sales. Net sales for the nine months ended September 30, 2002, were $390.5 million, an increase of $11.1 million, or 2.9%, versus net sales of $379.4 million for the nine months ended September 30, 2001. The sales growth was primarily the result of a 5.1% increase in same center sales in the Company's O&P patient-care practices offset by a $1.2 million, or 0.3%, decrease in outside sales of the distribution segment and a $4.7 million, or 1.2%, 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 nine months ended September 30, 2002 was $209.7 million, an increase of $18.3 million, or 9.6%, versus $191.4 million for the nine months ended September 30, 2001. Gross profit as a percentage of net sales increased to 53.7% in the first nine months of 2002 versus 50.4% in the first nine months of 2001. Specifically, the gross profit, as a percentage of sales, for the patient-care segment increased to 54.1% in the first nine months of 2002 versus 51.1% in the comparable period of 2001; similarly, the gross profit, as a percentage of sales, for the distribution segment increased to 16.9% in the first nine months of 2002 versus 13.8% in the comparable period 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 nine months ended September 30, 2002 increased by $8.8 million, or 6.7%, compared to the nine months ended September 30, 2001. Selling, general and administrative expenses as a percentage of net sales increased to 35.8% in the first nine months of 2002 compared to 34.5% 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 a $9.8 million 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 nine months ended September 30, 2002 were $7.5 million, a 60.3% decrease in such costs versus the $18.9 million for the nine months ended September 30, 2001. The decrease was due principally to the discontinuation of amortization related to goodwill commencing January 1, 2002 pursuant to SFAS No. 142, which had been $9.9 million during the first nine months of 2001, and also to the sale of SOGI in the fourth quarter of 2001. Unusual Charges. Unusual charges for the nine months ended September 30, 2001 amounted to $16.2 million, which consisted of the following one-time costs: (i) restructuring charges of $3.7 million principally related to severance and lease termination expenses; (ii) an $8.0 million loss 28 on the disposal of substantially all the manufacturing assets of SOGI; and (iii) $4.5 million in other charges primarily related to fees paid to JA&A in connection with development of the Company's performance improvement plan. Income from Operations. Principally as a result of the above, income from operations for the nine months ended September 30, 2002 was $62.4 million, an increase of $37.3 million, or 148.6%, compared to the nine months ended September 30, 2001. Income from operations as a percentage of net sales increased by 9.3 percentage points to 16.0% of net sales in the first nine months of 2002 versus 6.7% for the prior year's comparable period. Interest Expense, Net. Interest expense in the first nine months of 2002 was $28.9 million, a decrease of $5.2 million from the $34.1 million incurred in the first nine months of 2001. The decrease in 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 nine months ended September 30, 2002 was $13.6 million compared to a benefit of $4.3 million for the nine months ended September 30, 2001. The change in the income tax provision was due to the Company's return to profitability. Income (Loss) before Extraordinary Item. As a result of the above, we recorded income before extraordinary item of $19.8 million for the nine months ended September 30, 2002, compared to a loss before extraordinary item of $4.6 million in the comparable period in the prior year, an improvement of $24.4 million. Extraordinary Item. The extraordinary item of $2.8 million ($4.6 million pre-tax) in the nine months ended September 30, 2002, represents the write-off of debt issuance costs as a result of extinguishing $228.4 million of bank debt in connection with the Company's issuance of the $200.0 million principal amount of its 10 3/8% Senior Notes due 2009 (the "Senior Notes") and the establishment of a $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 $17.0 million for the nine months ended September 30, 2002, compared to net loss of $4.6 million in the comparable period in the prior year, an improvement of $21.6 million. Financial Condition, Liquidity And Capital Resources Our working capital at September 30, 2002 was $133.0 million compared to $109.2 million at December 31, 2001. Our cash and cash equivalents amounted to $22.0 million at September 30, 2002, and $10.0 million at December 31, 2001. The current ratio improved to 2.8 to 1 at September 30, 2002, compared to 2.3 to 1 at December 31, 2001. Available cash under our Revolving Credit Facility increased to $49.0 million at September 30, 2002 compared to $25.2 million at December 31, 2001. 29 Net cash provided by operating activities for the nine months ended September 30, 2002 was $41.3 million, compared to $28.7 million provided by operating activities in the nine months ended September 30, 2001. The $12.6 million increase was primarily due to the increase in the Company's net income. Net cash used in investing activities was $9.4 million for the nine months ended September 30, 2002, versus $9.0 million for the same period in the prior year. The increase in net cash used was primarily due to expenditures made on development of the Company's new billing system. Net cash used in financing activities was $20.0 million for the nine months ended September 30, 2002. During that period, the Company received $200.0 million in proceeds from the sale of the Senior Notes, which 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 prior 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 to the aforementioned proceeds, the Company received $3.1 million in proceeds from the exercise of stock options, offset by: (i) payment of approximately $2.4 million to JA&A to repurchase 601,218 shares underlying an outstanding option to purchase shares of the Company's common stock, as discussed below, (ii) scheduled principal payments of $8.5 million on our long-term debt, (iii) a net paydown of $10.5 million of our Revolving Credit Facility and (iv) payment of $1.7 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 underlying the Senior Notes 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 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 unregistered notes except that the new notes are free of the transfer restrictions that applied to the 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 30 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' 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. As of September 30, 2002, we were in compliance with these covenants. We assess, on a quarterly basis, our compliance with these covenants and monitor any matters critical to continue its compliance. 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 our contract with JA&A, the invoices were satisfied by the payment of $1.1 million in cash and the issuance of a nonqualified option to purchase 1,202,436 shares of the Company's common stock at an exercise price of $1.40 per share. The option was 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 repurchase 601,218 of the shares underlying such previously granted option for a payment of $3.98 per share, or a total of $2,392,704, which was paid during the third quarter of 2002 and recorded as a reduction in additional paid-in capital. On July 23, 2002, the Company's common stock opened for trading at $12.00 per share. In accordance with our agreement with JA&A, the Company filed a Registration Statement on Form S-3 with the Securities and Exchange Commission to register the remaining 601,218 shares underlying the outstanding 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 accordance with the sale of any shares that JA&A may acquire by exercise of the option, JA&A has agreed to limit sales of such shares 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. 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. 31 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. 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 No. 145"). Under SFAS No. 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 No. 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 No. 145 is effective for fiscal years beginning after May 15, 2002. SFAS No. 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 No. 146"). Under SFAS No. 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 No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The Company does not expect SFAS No. 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 32 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. 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 and Chief Executive Officer (and then President), and Richard A. Stein, our former Chief Financial Officer, Secretary and Treasurer (the "Class Action Lawsuit"). 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. 33 The Class Action Lawsuit has been dismissed by the District Court for failure to comply with statutory requirements. On November 5, 2002, plaintiffs filed a notice of appeal to the United States Court of Appeals for the Fourth Circuit. The Company believes that the allegations have no merit and is vigorously defending the Class Action 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. 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. 34 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk We have existing obligations relating to our Senior Notes, Senior Subordinated Notes, subordinated seller notes, and outstanding redeemable preferred stock. We do not have cash flow exposure to changing interest rates on these obligations because the interest and dividend rates of these securities are fixed. However, as discussed below, we entered into two fixed-to-floating interest rate swaps, in connection with the sale of our Senior Notes, whereby the aggregate notional amount of the swaps equaled one-half of the principal amount of the Senior Notes. We have a $75 million Revolving Credit Facility, with an outstanding balance of $26 million at September 30, 2002, as discussed in Note H to Hanger's Consolidated Financial Statements ("Note H"). The rates at which interest accrues under the entire outstanding balance are variable. In addition, 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, we entered into two fixed-to-floating interest rate swaps with an aggregate notional amount of $100 million in connection with the sale of our Senior Notes, as discussed in Note H. Variable rate debt and fixed-to-floating interest rate swaps subject us to cash flow exposure resulting from changing interest rates, as illustrated in the table below. Presented below is an analysis of our financial instruments as of September 30, 2002 that are sensitive to changes in interest rates. The table demonstrates the change in cash flow related to the Senior Notes, as affected by the related fixed-to-floating interest rate swaps, and the outstanding balance under the Revolving Credit Facility, calculated for an instantaneous parallel shift in interest rates, plus or minus 50 basis points ("BPS"), 100 BPS, and 150 BPS.
Annual Interest Expense Given an No Change Annual Interest Expense Given an Interest Rate Decrease of X Basis in Interest Interest Rate Increase of X Basis Cash Flow Risk Points Rates Points -------------------------------- --------------------------------- ----------- --------------------------------- (in thousands) (150 BPS) (100 BPS) (50 BPS) Fair Value 50 BPS 100 BPS 150 BPS Senior Notes (as affected by related interest-rate swaps) $ 15,548 $ 16,048 $ 16,548 $ 17,048 $ 17,548 $ 18,048 $ 18,548 Revolving Credit Facility $ 988 $ 1,118 $ 1,248 $ 1,378 $ 1,508 $ 1,638 $ 1,768 -------------------------------------------------------------------------------------- $ 16,536 $ 17,166 $ 17,796 $ 18,426 $ 19,056 $ 19,686 $ 20,316 ======================================================================================
35 ITEM 4. Controls and Procedures Based upon an evaluation within the 90 days prior to the filing date of this report, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect the Company's internal controls subsequent to the date of the evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. 36 PART II OTHER INFORMATION 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, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.2 Written Statement of the Chief Financial Officer Pursuant to 18 U.S.C. ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Forms 8-K. Current Report on Form 8-K dated August 22, 2002, providing the disclosures required by paragraph 61 of Statement of Financial Accounting Standards No. 142--"Goodwill And Other Intangible Assets". 37 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: November 13, 2002 /s/ Ivan R. Sabel -------------------------------------- Ivan R. Sabel, CPO Chairman and Chief Executive Officer (Principal Executive Officer) Dated: November 13, 2002 /s/ George E. McHenry --------------------------------------- George E. McHenry Chief Financial Officer (Principal Financial Officer) Dated: November 13, 2002 /s/ Glenn M. Lohrmann --------------------------------------- Glenn M. Lohrmann Controller (Chief Accounting Officer) 38 CERTIFICATIONS I, Ivan R. Sabel, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Hanger Orthopedic Group, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 13, 2002 /s/ Ivan R. Sabel ------------------------------------- Ivan R. Sabel, CPO Chairman and Chief Executive Officer 39 I, George E. McHenry, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Hanger Orthopedic Group, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 13, 2002 /s/ George E. McHenry ------------------------------ George E. McHenry Chief Financial Officer 40