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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the fiscal year ended DECEMBER 31, 2000
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.
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(Exact name of registrant as specified in its charter.)
Delaware 84-0904275
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Two Bethesda Metro Cener (Suite 1200, Bethesda, MD 20814
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(Address of principal executive offices) (Zip Code)
Registrant's phone number, including area code: (301) 986-0701
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $.01 per share
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(Title of Class)
Securities registered pursuant to section 12(g) of the Act: None.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days: Yes [X] No [ ]
The aggregate market value of the registrant's Common Stock, par value
$.01 per share, held as of March 29, 2001 by non-affiliates of the registrant
was $26,474,003 based on the $1.40 closing sale price per share of the Common
Stock on the New York Stock Exchange on such date.
As of March 29, 2001, the registrant had 18,910,002 shares of its Common
Stock issued and outstanding.
Indicate by check mark if disclosure of delinquent filers pursuant to
item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
DOCUMENTS INCORPORATED BY REFERENCE
The information called for by Part III of the Form 10-K is incorporated
by reference from the registrant's definitive proxy statement or amendment
hereto which will be filed not later than 120 days after the end of the fiscal
year covered by this report.
ITEM 1. BUSINESS.
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Overview
We develop, acquire and operate orthotic and prosthetic ("O&P")
patient-care centers. Our O&P centers are staffed by orthotists and
prosthetists, who design, fabricate, fit and supervise the use of external
musculoskeletal support devices and artificial limbs. We also manufacture
custom-made and prefabricated O&P devices and we are the country's largest
distributor of O&P components and finished O&P patient-care products.
Our products are technologically advanced, custom devices designed for
adding functionality to patients' lives. We serve a clearly identified patient
need and provide tangible benefits to patients. Our industry is characterized
by stable, recurring revenues resulting from the need for regular, periodic
replacement or modification of O&P devices.
On July 1, 1999, we acquired NovaCare Orthotics & Prosthetics, Inc.
("NovaCare O&P"). As a result of that acquisition, Management believes we are
the leading provider of O&P patient-care services in the United States.
NovaCare O&P was an active acquirer of O&P businesses, having acquired over 90
O&P businesses from 1992 until we acquired it on July 1, 1999. At December 31,
2000, we had 620 patient-care centers and approximately 888 practitioners in
44 states and the District of Columbia.
Our acquisition of NovaCare O&P more than doubled our number of
patient-care centers and certified O&P practitioners. The acquisition provided
national scope to our operations, expanding coverage into 11 additional
states, including Illinois, Missouri, Oklahoma and Iowa, and increasing our
presence in key existing markets, including California, New York, Arizona,
Florida, Texas and Pennsylvania.
As a result of unforeseen and unanticipated difficulties encountered by
us in connection with the integration of NovaCare O&P's operations with our
operations, and the related adverse financial consequences associated with
those difficulties, we engaged the consulting firm of Jay Alix & Associates
("JA&A") in late 2000 to assist us in the development of a comprehensive
performance improvement program. In January 2001, we developed a cost savings
program that included plans for targeted spending reductions, improving the
utilization and efficiency of support services, including claims processing,
the refinement of materials purchasing and inventory management, and
consolidation of distribution services. In addition, we are seeking to enhance
revenues through improved marketing efforts and more efficient billing
procedures.
Competitive Strengths
We believe that the following competitive strengths will enable us to
continue to increase revenues, EBITDA and market share by (i) providing
"one-stop shopping" to large, national payor organizations and other
customers, and (ii) maximizing operating efficiencies and economies of scale:
Leading Market Position in a Fragmented Industry. Management believes we
are the nation's largest provider of O&P services, with approximately a 25%
market share, 888 O&P practitioners and 620 O&P patient-care centers in 44
states and the District of Columbia.
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Vertically Integrated Provider. Management believes we are the only
vertically integrated provider of O&P services in the United States. Along
with our patient-care services operations, we also manufacture custom-made and
prefabricated O&P devices. Additionally, we are the nation's largest
distributor of O&P components and finished O&P patient-care products, which
allows us to reduce the materials costs of our patient-care centers and offer
prompt delivery of components and products.
Balanced Business Mix. Our business is fairly evenly distributed in terms
of both service mix and payor mix. For the year ended December 31, 2000, our
consolidated orthotics and prosthetics, manufacturing and distribution
revenues made up approximately 92%, 2% and 6%, respectively, of consolidated
net sales. For the same period, our combined payor mix was approximately 62%
private pay, and 38% Medicare, Medicaid and U.S. Veterans Administration.
Innovative Products and Strong Brand Equity. We have earned a strong
reputation within the O&P industry for the development and use of innovative
technology. For example, our patented Charleston Bending Brace, Seattle Foot,
Ortho-Mold, Lenox Hill Knee Brace and prosthetic Sabolich Socket have
increased patient comfort and capability, and can significantly shorten the
rehabilitation process. The quality of our products and the success of our
technological advances have generated broad media coverage, enhancing our
brand equity among payors, patients and referring physicians.
Experienced and Committed Management Team. We have a senior management
team with extensive experience in the O&P business. Ivan R. Sabel, our
Chairman of the Board, President and Chief Executive Officer, is a certified
orthotist and prosthetist and has worked in the O&P industry for 33 years,
including 20 years as a practitioner. He has led our senior management team
since 1995 and has been a member of that team since 1986. Richmond L. Taylor,
the President of our patient-care operations, has been in the O&P field for
more than 12 years. We will continue to provide senior management and O&P
practitioners of our Company with performance-based bonuses, stock options and
opportunities for corporate advancement that will give them a significant
financial interest in our performance.
Business Strategy
Our objective is to build on our position as a full-service, nationwide
O&P company focused on the operation of O&P patient-care centers and the
manufacture and distribution of O&P products. The key elements of our strategy
for achieving this objective are to:
Implement Acquisition-Related Synergies. We believe we can reduce costs
and increase net sales by continuing to refine our acquisition-related
synergies. We expect that our operating margins will improve due to
anticipated reductions in administrative and personnel costs and also expect
to reduce materials costs at NovaCare O&P's patient-care centers due to
increased purchases from Hanger Orthopedic Group. We will continue to attempt
to increase net sales by cross-selling Hanger Orthopedic Group and NovaCare
O&P products at our patient-care centers and using our expanded geographic
coverage to exploit national contracting opportunities.
Increase Number of O&P Managed Care Contracts. We intend to continue to
pursue O&P managed care contracts to increase market share and net sales
growth. A national network of O&P patient-care centers will enable us to
negotiate for contracts with any local, regional or national third-party payor
seeking a single-source O&P provider.
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Expand our O&P Manufacturing and Distribution Operations. Expansion of
our patient-care division will increase captive demand for our manufacturing
and distribution business. As the volume of our distribution increases, it
will allow us to achieve volume discounts in the cost of our distributed
products. Our manufacturing division should also benefit from increased net
sales at the distribution division by providing proprietary products to meet
the increased demand. Our manufacturing efforts will focus on the acquisition
and/or development of proprietary, patented products, such as our Lenox Hill
knee brace, Charleston Bending Brace, Seattle Foot, Ortho-Mold braces and
Sabolich Socket.
Expand and Improve Operations at Existing and Acquired Patient-Care
Centers. While we are currently focusing on improving the performance of our
existing patient-care centers and reducing costs, which will substantially
reduce the likelihood of acquisitions or the opening of new centers in 2001,
our size will enable us to improve margins by spreading administrative fixed
costs and capital expenditures for state-of-the-art equipment such as CAD/CAM
systems. We can also enhance sales by using brand-based marketing programs
that are generally not available to practitioners in smaller, independent
practices.
3
Patient-Care Centers and Facilities
As of December 31, 2000, we operated a total of 620 patient-care centers,
six distribution facilities and seven manufacturing facilities, substantially
all of which are leased, as detailed in the following table:
Distribution Manufacturing
Jurisdiction Patent-Care Centers Facilities Facilities
- ------------ ------------------- ------------ -------------
Alabama..................... 13 - -
Arizona..................... 18 - 1
Arkansas.................... 5 - -
California.................. 65 1 2
Colorado.................... 9 - -
Connecticut................. 15 - -
Delaware.................... 1 - -
District of Columbia......... 2 - -
Florida...................... 38 1 1
Georgia...................... 23 1 1
Illinois..................... 28 1 -
Indiana...................... 13 - -
Iowa......................... 13 - -
Kansas....................... 13 - -
Kentucky..................... 9 - -
Louisiana.................... 11 - -
Maine........................ 3 - -
Maryland..................... 8 1 -
Massachusetts................ 8 - -
Michigan..................... 7 - -
Minnesota.................... 10 - -
Mississippi.................. 11 - -
Missouri..................... 15 - 1
Montana....................... 6 - -
Nebraska...................... 11 - -
Nevada........................ 5 - -
New Hampshire................. 4 - -
New Jersey.................... 13 - -
New Mexico.................... 11 - -
New York...................... 30 - -
North Carolina................ 13 - -
North Dakota.................. 1 - -
Ohio.......................... 29 - -
Oklahoma...................... 12 - -
Oregon........................ 19 - -
Pennsylvania................... 38 - -
South Carolina................. 12 - -
South Dakota................... 2 - -
Tennessee...................... 15 - -
Texas.......................... 24 1 -
Virginia....................... 12 - -
West Virginia.................. 8 - -
Washington..................... 9 - 1
Wisconsin...................... 6 - -
Wyoming........................ 2 - -
Total..................... 620 6 7
=== = =
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Industry Background
Orthotics is the design, fabrication, fitting and supervised use of
custom-made braces and other devices that provide external support to treat
musculoskeletal disorders. Musculoskeletal disorders are ailments of the back,
extremities or joints caused by traumatic injuries, chronic conditions,
diseases, congenital disorders or injuries resulting from sports or other
activities. Prosthetics is the design, fabrication and fitting of custom-made
artificial limbs for patients who have lost limbs as a result of traumatic
injuries, vascular diseases, diabetes, cancer or congenital disorders.
Care of O&P patients is part of a continuum of rehabilitation services
from diagnosis to treatment and prevention of future injury. This continuum
involves the integration of several medical disciplines that begins with the
attending physician's diagnosis. Once a course of treatment is determined, the
physician, generally an orthopedic surgeon, vascular surgeon or physiatrist,
refers a patient to an O&P patient-care service provider for treatment. An O&P
practitioner then consults with both the referring physician and the patient
to formulate the prescription for and design of, an orthotic or prosthetic
device to meet the patient's needs.
We estimate that the patient-care O&P industry in the United States
represented approximately $1.9 billion in sales in 2000. Key trends expected
to increase demand for orthopedic rehabilitation services include the
following:
Growing Elderly Population. The growth rate of the over-65 age group is
nearly triple that of the under-65 age group. With broader medical insurance
coverage, increasing disposable income, longer life expectancy, greater
mobility and improved technology and devices, the elderly are expected to seek
orthopedic rehabilitation services more often.
Cost-Effective Reduction in Hospitalization. As public and private payors
encourage reduced hospital admissions and reduced length of stay, out-patient
rehabilitation is in greater demand. O&P services and devices have enabled
patients to become ambulatory more quickly after receiving medical treatment
in the hospital. We believe that significant cost savings can be achieved
through the early use of O&P services. The provision of O&P services in many
cases reduces the need for more expensive treatments, thus representing a cost
savings to the third-party payor.
Growing Physical Health Consciousness. There is a growing emphasis on
physical fitness, leisure sports and conditioning, such as running and
aerobics, which has led to increased injuries requiring orthopedic
rehabilitative services and products. In addition, as the current middle-age
population ages, it brings its more active life-style and accompanying
emphasis on physical fitness to the over-65 age group. These trends are
evidenced by the increasing demand for new devices which provide support for
injuries, prevent further or new injuries or enhance physical performance.
Advancing Technology. The range and effectiveness of treatment options
have increased in connection with the technological sophistication of O&P
devices. Advances in design technology and lighter, stronger and more
cosmetically acceptable materials have enabled the industry to produce new O&P
products, which provide greater comfort, protection and patient acceptability.
Therefore, treatment can be more effective and of shorter duration,
contributing to greater mobility and a more active lifestyle for the patient.
As a result of advancing technology, orthotic devices have become more
prevalent and visible in many sports, including skiing, running and tennis.
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Need for Replacement and Continuing Care. Because the useful life of most
custom fitted and fabricated O&P devices is approximately three to five years,
such devices need retrofitting and replacement. There is also an attendant
need for continuing patient-care services, which contributes to the increasing
demand for orthopedic rehabilitation.
Industry Overview. The O&P patient-care services market is highly
fragmented and relatively under-penetrated by multi-site operators. There are
an estimated 3,300 certified prosthetists and/or orthotists and approximately
2,850 O&P patient-care centers in the United States. We estimate that we
account for approximately 25% of total estimated O&P patient-care net sales.
We do not believe that any other competitor has a market share of more than 5%
of total estimated O&P patient-care net sales. We believe that the O&P
industry will continue to consolidate as a result of a variety of factors,
including: (i) increased pressures from managed care; (ii) demonstrated
benefits from economies of scale; and (iii) desire by independent orthotists
and prosthetists to focus more on patient care and less on administration.
Increased Managed Care Penetration. The expanding geographical reach of
the large managed care organizations makes it increasingly important for them
to contract for their patient-care needs with counterparts who have large,
national operations. Managed care companies prefer to contract with a single
provider for all their O&P patient-care services. As a result, small
independent O&P practices feel pressure to consolidate in order to access
managed care referrals.
Economies of Scale. A significant portion of the cost of O&P services is
attributable to the cost of materials used in orthoses and prostheses.
Achieving purchase discounts through group purchasing can increase
profitability at each patient-care center.
Financial Liquidity for O&P Practices. The security of a large O&P
network is extremely appealing to small providers who desire to reduce the
financial and personal liabilities of their businesses. Through consolidation,
individual providers are able to realize some financial liquidity while
enabling them to continue to provide patient-care services as employees of a
large O&P services provider.
Patient-Care Center Administration
We provide all senior management, accounting, accounts payable, payroll,
sales and marketing, human resources and management information systems
services for our patient-care centers. By providing these services on a
centralized basis, we are able to provide such services to our patient-care
centers and practitioners more efficiently and cost-effectively than if such
services had to be generated at each center. The centralization of these
services also permits our certified practitioners to allocate a greater
portion of their time to patient-care activities by reducing the
administrative responsibilities of operating the patient-care centers.
We also develop and implement programs designed to enhance the efficiency
of our clinical practices. Such programs include: (i) sales and marketing
initiatives to attract new-patient referrals by establishing relationships
with physicians, therapists, employers, managed care organizations, hospitals,
rehabilitation centers, out-patient clinics and insurance companies; (ii)
professional management and information systems to improve efficiencies of
administrative and operational functions; (iii) professional-education
programs for practitioners emphasizing new developments in the increasingly
sophisticated field of O&P clinical therapy; (iv) the regionalization of
fabrication and purchasing activities, which provides overnight access to
component parts and products at prices that are typically 25% lower than
traditional procurement methods; and (v) access to expensive, state-of-the-art
6
equipment that is financially more difficult for smaller, independent
facilities to obtain.
We believe that the application of sales and marketing techniques is a
key element of our operational strategy. Due primarily to the fragmented
nature of the industry, the success of an O&P patient-care center has been
largely a function of its local reputation for quality of care, responsiveness
and length of service in the community. Individual practitioners have relied
almost exclusively on referrals from local physicians or physical therapists
and typically have not utilized advanced marketing techniques. We are in the
process of developing a centralized marketing department.
Patient-Care Services
At December 31, 2000, we provided O&P patient-care services through 620
O&P patient-care centers and approximately 888 patient-care practitioners in
44 states and the District of Columbia. The majority of our practitioners are
certified practitioners or candidates for formal certification by the O&P
industry certifying boards. Each of our patient-care centers is closely
supervised by one or more certified practitioners. The balance of our
patient-care practitioners are highly trained technical personnel who assist
in the provision of services to patients and fabricate various O&P devices.
A patient in need of O&P patient-care services is referred to one of our
patient-care centers upon a determination by the attending physician of a
course of treatment. One of our practitioners then consults with both the
referring physician and the patient to formulate the prescription for, and
design of, an orthotic or prosthetic device to meet the patient's needs.
The fitting process involves several stages in order to successfully
achieve desired functional and cosmetic results. The practitioner creates a
cast and takes detailed measurements of the patient to ensure an anatomically
correct fit. All of the prosthetic devices fit by our practitioners are custom
designed and fabricated by skilled practitioners for balance, fit, support and
comfort. Of the orthotic devices provided by us, a majority are custom
designed, fabricated and fit and the balance are prefabricated but custom fit.
Custom devices are fabricated by our skilled technicians using the
castings, measurements and designs made by the practitioner. Technicians use
advanced materials and technologies to fabricate a custom device under quality
assurance guidelines. After final adjustments to the device by the
practitioner, the patient is instructed in the use, care and maintenance of
the device. A program of scheduled follow-up and maintenance visits is used to
provide post-fitting treatment, including adjustments or replacements as the
patient's physical condition and lifestyle change.
A substantial portion of our O&P services involves treatment of a patient
in a non-hospital setting, such as one of our patient-care centers, a
physician's office, an out-patient clinic or other facility. In addition, O&P
services are increasingly rendered to patients in hospitals, nursing homes,
rehabilitation centers and other alternate-site health care facilities. In a
hospital setting, the practitioner works with a physician to provide either
orthotic devices or temporary prosthetic devices that are later replaced by
permanent prostheses.
We also operate in-patient O&P patient-care centers at The Rusk Institute
of Rehabilitation Medicine at the New York University Medical Center in New
York, New York, the Harmarville Rehabilitation Center in Pittsburgh,
Pennsylvania and the Newington Children's Hospital in Newington, Connecticut.
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OPNET
In 1995, we formed OPNET, a proprietary national preferred provider O&P
referral network serving managed care organizations, including HMOs and PPOs.
Through this network, managed care organizations can contract for O&P services
with any O&P patient-care center in the OPNET network. As of December 31,
2000, OPNET had a network of 701 patient-care centers (620 of which are owned
and operated by us) serving 1,109 managed care plans.
Manufacturing and Distribution
In addition to on-site fabrication of custom O&P devices incidental to
the services rendered at its O&P patient-care centers, we manufacture O&P
components and finished patient-care products for both the O&P industry and
our own patient-care centers. We manufacture components and finished products
under various name brands such as Lenox Hill, CASH Brace, Ortho-Mold,
Charleston Bending Brace, DOBI-Symplex, Seattle Limb Systems and Sea Fab. This
manufacturing activity takes place at a state-of-the-art facility located in
Seattle, Washington that we acquired in 1998. The principal products
manufactured are prefabricated and custom-made spinal orthoses as well as
custom-made and off-the-shelf derotation knee braces. We distribute O&P
components and finished patient-care products to the O&P industry and to our
own patient-care practices. We inventory over twenty (20) thousand items, a
majority of which are manufactured by other companies and are distributed by
us.
The Sabolich Socket is a patented design that presently is only available
at our patient-care centers. A socket is the connecting point between a
prosthesis and the body of the patient. The Sabolich Socket is a highly
contoured flexible socket which has revolutionized both above-knee and
below-knee prosthetics. It features anatomically designed channels to
accommodate various muscle, bone, tendon, vascular and nerve areas. This
unique approach to socket design is generally accepted as superior to previous
socket systems.
Our distribution capability allows our personnel faster access to the
products needed to fabricate devices for patients. This is accomplished at
competitive prices, as a result of either manufacturing by us or direct
purchases by us from other manufacturers.
Marketing of our manufactured products and distribution services is
conducted on a national basis, through a dedicated sales force, catalogues and
exhibits at industry and medical meetings and conventions. We direct
specialized catalogues to segments of the health care industry, such as
orthopedic surgeons and physical and occupational therapists.
To provide timely custom fabrication and service to its patients, we
employ technical personnel and maintain laboratories at each of our
patient-care centers. We use advanced computer-aided design and computer-aided
manufacturing ("CAD/CAM") technology to produce precise and uniform products.
We have several large, fully staffed central fabrication facilities to service
patient-care centers. These strategically located facilities enable us to
fabricate those O&P products that are more easily produced in larger
quantities and in a more cost-effective manner, as well as serving as an
auxiliary production center for products normally fabricated at individual
patient-care centers.
We have earned a strong reputation within the O&P industry for the
development and use of innovative technology in our products which has
increased patient comfort and capability, and can significantly shorten the
8
rehabilitation process. The quality of our products and the success of our
technological advances have generated broad media coverage, enhancing our
brand equity among payors, patients and referring physicians.
Research & Development
We will continue to engage actively in O&P product research and
development within our current cost parameters. Our manufacturing division
currently establishes an annual research and development budget in an amount
approximating ten percent of the net sales of the manufacturing division for
the prior year. This budgeted amount is then divided into two categories, with
approximately one-third of such amount being applied to improving existing
products manufactured by us and the remaining portion being applied to
research and development of new products. Improvements to existing products
are made through the use of newer and more advanced materials, as well as
through requests by existing purchasers of products who express their
willingness to purchase a greater number of such products if requested product
improvements are implemented. Thus, improvements to existing products are
expected to increase sales of such products, especially to those customers who
requested the product improvements.
Research and development of new products begins with numerous meetings
with patient-care practitioners and sales personnel in the O&P industry to
identify new product needs. Research and development expenditures for new
products are divided between two categories, with a majority of such
expenditures applied to new products which have a high probability of
successful sales with low technical risk and small development effort to
manufacture the product, and with the remaining amount applied to new products
which have higher technical risk and a higher risk of failure, but with higher
sales potential.
Acquisitions
From 1986 to June 1999, Hanger Orthopedic Group acquired over 75
businesses in 31 states and the District of Columbia. From 1992 to June 1999,
NovaCare O&P acquired over 90 O&P businesses in 37 states. On July 1, 1999,
Hanger Orthopedic Group acquired NovaCare O&P. Subsequent to our acquisition
of NovaCare O&P, we acquired one O&P business in 1999. In 2000, we acquired
five small O&P businesses.
As a result of our current emphasis on cost-reduction measures and other
internal restructuring, we do not anticipate making any acquisitions during
2001.
New-Center Development
In addition to acquired patient-care centers, we have historically
developed new satellite patient-care centers in existing markets with
underserved demand for O&P services. These satellite centers require less
capital to develop than complete O&P centers since the satellite centers
usually consist of only a waiting room and patient fitting rooms, but without
a fabrication laboratory for creating O&P devices. An O&P practitioner will
spend one or two days each week in a satellite center treating those patients
who find it inconvenient to visit the O&P practitioner's primary center.
These satellite centers also tend to receive new patient referrals from
hospitals and physicians located near the newly developed center, driving new
patient growth and center revenue. While a partial revenue shift occurs from
the O&P practitioner's main center to the satellite center because the O&P
practitioner is now seeing some of the same patients out of a new center, the
additional patient volume in the satellite center increases the O&P
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practitioner's overall revenue. If demand for O&P services at a satellite
center increases beyond the ability of the O&P practitioner to service in one
or two days a week, the Company will staff the satellite office on a full-time
basis. We estimate that the cost of opening a new satellite patient-care
center is approximately $100.0, which includes equipment, leasehold
improvements and working capital. We expect a new patient-care center to reach
profitability, as measured by EBITDA, within six months to one year of
opening. No assurance can be given that we will be successful in achieving
these start-up and profitability goals with regard to new patient-care
centers.
Reimbursement Sources
The principal reimbursement sources for our O&P services are: (i) private
payor/third-party insurer sources which consist of individuals, private
insurance companies, HMOs, PPOs, hospitals, vocational rehabilitation,
workers' compensation and similar sources; (ii) Medicare, which is a federally
funded health-insurance program providing health insurance coverage for
persons aged 65 or older and certain disabled persons; (iii) Medicaid, which
is a health-insurance program jointly funded by federal and state governments
providing health insurance coverage for certain persons in financial need,
regardless of age, and which may supplement Medicare benefits for financially
needy persons aged 65 or older; and (iv) the VA, with which Hanger has entered
into contracts to provide O&P services.
Medicare, Medicaid, the VA and certain state agencies, which accounted
for approximately 53.7%, 41.0% and 38.4% of our net sales in 1998, 1999 and
2000, respectively (based on a sampling of approximately 41%, 79% and 84% of
patient-care centers in 1998, 1999 and 2000, respectively), have set maximum
reimbursement levels for payments for O&P services and products. The health
care policies and programs of these agencies have been subject to changes in
payment methodologies during the past several years. There can be no assurance
that future changes will not reduce reimbursements for O&P services and
products from these sources.
We provide O&P services to eligible veterans pursuant to several
contracts with the VA. The VA establishes its reimbursement rates for itemized
products and services on a competitive bidding basis. The contracts, awarded
on a non-exclusive basis, establish the amount of reimbursement to the
eligible veteran if the veteran should choose to use our products and
services. Hanger Orthopedic Group has been awarded VA contracts in the past
and expects that it will obtain additional contracts when its present
agreements expire.
Competition
The competition among O&P patient-care centers is primarily for referrals
from physicians, therapists, employers, HMOs, PPOs, hospitals, rehabilitation
centers, out-patient clinics and insurance companies on both a local and
regional basis. We believe that distinguishing competitive factors in the O&P
industry are quality and timeliness of patient care and, to a lesser degree,
charges for services. We compete with others in the industry for trained
personnel. To date, however, we have been able to achieve our staffing needs
and have experienced a relatively normal turnover rate of employees.
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Government Regulation
Certification and Licensure
Most states do not require separate licensure for O&P practitioners.
However, several states currently require O&P practitioners to be certified by
an organization such as the American Board for Certification.
The American Board for Certification conducts a certification program for
practitioners and an accreditation program for patient-care centers. The
minimum requirements for a certified practitioner are a college degree,
completion of an accredited academic program, one to four years of residency
at a patient-care center under the supervision of a certified practitioner and
successful completion of certain examinations. Minimum requirements for an
American Board for Certification-accredited patient-care center include the
presence of a certified practitioner and specific plant and equipment
requirements. While we endeavor to comply with all state licensure
requirements, no assurance can be given that we will be in compliance at all
times with these requirements.
We provide services under various contracts to federal agencies. These
contracts are subject to regulations governing federal contracts, including
the ability of the government to terminate for its convenience.
Medical Device Regulation
We manufacture and distribute products that are subject to regulation as
medical devices by the Food and Drug Administration ("FDA") under the Federal
Food, Drug, and Cosmetic Act and accompanying regulations. We believe that the
products we manufacture and/or distribute, including O&P accessories and
components, are exempt from FDA's regulations for premarket clearance or
approval requirements and from requirements relating to quality system
regulation ("QSR"): (except for certain recordkeeping and complaint handling
requirements). We are required to adhere to regulations regarding adverse
event reporting, and are subject to inspection by the FDA for compliance with
all applicable requirements. Labeling and promotional materials also are
subject to scrutiny by the FDA and, in certain circumstances, by the Federal
Trade Commission. Although we have never been challenged by FDA for
noncompliance with FDA requirements, no assurance can be given that we would
be found to be or to have been in compliance at all times. Noncompliance could
result in a variety of civil and/or criminal enforcement actions, which could
have a material adverse effect on our business and results of operations.
Fraud and Abuse
Violations of these laws are punishable by criminal and/or civil
sanctions, including, in some instances, imprisonment and exclusion from
participation in federal health care programs, including Medicare, Medicaid,
VA health programs and CHAMPUS. We have never been challenged by a
governmental authority under any of these laws and believe that, based on this
history, our operations are in material compliance with such laws. However,
because of the far-reaching nature of these laws, there can be no assurance
that one or more of our practices would not be required to alter its practices
as a result, or that the occurrence of one or more of these events would not
result in a material adverse effect on our business and results of operations.
11
Antikickback Laws. Our operations are subject to federal and state
antikickback laws. The Federal Health Care Programs Antikickback Statute
(section 1128B(b) of the Social Security Act) prohibits persons or entities
from knowingly and willfully soliciting, offering, receiving, or paying any
remuneration in return for, or to induce, the referral of persons eligible for
benefits under a Federal Health Care Program (including Medicare, Medicaid,
the VA health programs and CHAMPUS), or the ordering, purchasing or leasing of
items or services that may be paid for, in whole or in part, by a Federal
Health Care Program. The statute may be violated when even one purpose (as
opposed to a primary or sole purpose) of a payment is to induce referrals or
other business. The regulations create a small number of "safe harbors."
Practices which meet all the criteria of an applicable safe harbor will not be
deemed to violate the statute; practices that do not satisfy all elements of a
safe harbor do not necessarily violate the statute, although such practices
may be subject to scrutiny by enforcement agencies. Several states also have
antikickback laws which vary in scope and may apply regardless of whether a
Federal Health Care Program is involved.
These laws may apply to certain of our operations. We have instituted
various types of discount programs for individuals or entities that purchase
products and services. We also maintain financial relationships with
individuals and entities who may: (i) purchase our products and services; (ii)
refer patients to our O&P patient-care centers; or (iii) receive referrals
through OPNET. These relationships include, among other things, lease
arrangements with hospitals and OPNET participation arrangements. Because some
of these arrangements may not satisfy all elements of an applicable safe
harbor, they could be subject to scrutiny and challenge under one or more such
laws.
HIPAA Violations. The Health Insurance Portability and Accountability Act
("HIPAA") provides for criminal penalties for, among other offenses, health
care fraud, theft or embezzlement in connection with health care, false
statements relating to health care matters, and obstruction of criminal
investigation of health care offenses. Unlike the antikickback laws, these
offenses are not limited to Federal Health Care Programs.
In addition, HIPAA authorizes the imposition of civil monetary penalties
where a person offers or pays to any individual eligible for benefits under a
Federal Health Care Program remuneration that such person knows or should know
is likely to influence the individual to order or receive covered items or
services from a particular provider, practitioner or supplier. Excluded from
the definition of "remuneration" are incentives given to individuals to
promote the delivery of preventive care (excluding cash or cash equivalents),
incentives of nominal value and certain differentials in or waivers of
coinsurance and deductible amounts.
These laws may apply to certain of our operations. As noted above, we
have established various types of discount programs or other financial
arrangements with individuals and entities who purchase our products and
services and/or refer patients to our O&P patient-care centers. We also bill
third party payors and other entities for items and services provided at our
O&P patient care centers. While we endeavor to ensure that our discount
programs, other financial arrangements and billing practices comply with
applicable laws, such programs, arrangements and billing practices could be
subject to scrutiny and challenge under HIPAA.
False Claims Laws. We are also subject to federal and state laws
prohibiting individuals or entities from knowingly and willfully presenting,
or causing to be presented, claims for payment to third-party payors
(including Medicare and Medicaid) that are false or fraudulent or are for
items or services not provided as claimed. Each of our O&P patient-care
centers is responsible for preparation and submission of reimbursement claims
to third-party payors for items and services furnished to patients. In
addition, our personnel may, in some instances, provide advice on billing and
12
reimbursement for our products to purchasers. While we endeavor to assure that
our billing practices comply with applicable laws, if claims submitted to
payors are deemed to be false, fraudulent, or for items or services not
provided as claimed, we could face liability for presenting or causing to be
presented such claims.
Physician Self-Referral Laws. We are also subject to federal and state
physician self-referral laws. With certain exceptions, the federal
Medicare/Medicaid physician self-referral law (the "Stark" law, section 1877
of the Social Security Act) prohibits a physician from referring Medicare and
Medicaid beneficiaries to an entity for "designated health
services"--including prosthetics, orthotics and prosthetic devices and
supplies--if the physician has either an investment interest in the entity or
a compensation arrangement with the entity. An exception is recognized for
referrals made to a publicly traded entity in which the physician has an
investment interest if the entity's shares are traded on certain exchanges,
including the New York Stock Exchange, and had shareholders' equity exceeding
$75.0 million for its most recent fiscal year, or on average during the three
previous fiscal years. We meet these tests.
Antitrust
We are subject to federal and state antitrust laws which prohibit, among
other things, the establishment of ventures that result in certain
anticompetitive conduct. These laws have been applied to the establishment of
certain networks of otherwise competing health care providers. In September
1995, the Antitrust Division of the Department of Justice issued a business
review letter which concluded, in part, that the description of OPNET
voluntarily furnished to the Department of Justice by us "did not pose any
significant competitive issues" and, therefore, Department of Justice "has no
present intention of challenging [OPNET]" under federal antitrust law.
Although we are not able to assure that the continued operation of OPNET will
comply in all respects with the terms specified in the business review letter,
noncompliance with these terms does not mean that the antitrust authorities or
private parties would challenge the conduct, and we believe that the current
operation of OPNET is not anticompetitive and results in significant
efficiencies. However, the Department of Justice reserves the right to bring
an investigation or proceeding if it determines that OPNET is anticompetitive
in purpose or effect. There can be no assurance that the Department of Justice
will not bring an investigation or proceeding challenging OPNET (or other
aspects of our operations) under these laws, or that such an investigation or
proceeding would not result in a material adverse effect on our business and
results of operations.
Personnel
None of our employees are subject to a collective-bargaining agreement.
We believe that we have satisfactory relationships with our employees and
strive to maintain these relationships by offering competitive benefit
packages, training programs and opportunities for advancement. The following
table summarizes our employees as of December 31, 2000:
Part-time........................................... 171
Full-time............................................ 3,198
-------
Total............................................. 3,369
=======
13
Insurance
We currently maintain insurance of the type and in the amount customary
in the orthopedic rehabilitation industry, including coverage for malpractice
liability, product liability, workers' compensation and property damage. Our
general liability insurance coverage is $500.0 per incident, with a $50.0
million umbrella insurance policy. Based on our experience and prevailing
industry practices, we believe our coverage is adequate as to risks and
amount.
ITEM 2. PROPERTIES.
----------
As of December 31, 2000, Hanger operated 620 patient-care centers and
facilities in 44 states and the District of Columbia. Of these, 24 centers are
owned by Hanger. There are an additional four centers owned but not in use in
Georgia, New York, Pennsylvania and West Virginia. The remaining centers are
occupied under leases expiring between the years of 2001 and 2010. Hanger
believes that the centers leased or owned by it are adequate for carrying on
its current O&P operations at its existing locations, as well as its
anticipated future needs at those locations. Hanger believes it will be able
to renew such leases as they expire or find comparable or additional space on
commercially suitable terms.
Hanger also owns distribution facilities in Georgia and Texas, and leases
manufacturing and distribution facilities in Arizona, Missouri, Illinois,
Maryland, Florida, Washington and California. The Company leases its corporate
headquarters in Bethesda, Maryland. Substantially all of Hanger's properties
are pledged to collateralize bank indebtedness. See Note H to Hanger's
Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS.
-----------------
On November 28, 2000, a class action complaint (Norman Ottmann v. Hanger
Orthopedic Group, Inc., Ivan R. Sabel and Richard A. Stein; Civil Action No.
00CV3508) was filed against us in the United States District Court for the
District of Maryland on behalf of all purchasers of our common stock from
November 8, 1999 through and including January 6, 2000. The complaint also
names as defendants Ivan R. Sabel, our Chairman of the Board, President and
Chief Executive Officer, and Richard A. Stein, our former Chief Financial
Officer, Secretary and Treasurer.
The complaint alleges that during the above period of time, the
defendants violated Section 10(b) and 20(a) of the Securities Exchange Act of
1934 by, among other things, knowingly or recklessly making material
misrepresentations concerning our financial results for the quarter ended
September 30, 1999, and the progress of our 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 our common stock. The plaintiff seeks to recover damages
on behalf of all of the class members.
We believe that the allegations have absolutely no merit and plan to
vigorously defend the lawsuit.
Currently, Hanger is not a party to any other material legal proceedings.
Legal proceedings to which Hanger is subject arise in the ordinary course of
business.
14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
---------------------------------------------------
No matter was submitted during the fourth quarter of the fiscal year
covered by this report to a vote of stockholders.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.
------------------------------------
The following table sets forth information regarding our current
executive officers and certain of our subsidiaries:
Name Age Office with the Company
- ---- --- -----------------------
Ivan R. Sabel, CPO 56 Chairman of the Board, President,
Chief Executive Officer and
Director of the Company
Richmond L. Taylor 52 Executive Vice President of the
Company and Chief Operating Officer
of Hanger Prosthetics & Orthotics,
Inc. and HPO, Inc.
(Patient Care Services)
Dennis T. Currier 56 Chief Financial Officer
of the Company
James G. Cairns, Jr. 63 President and Chief Operating Officer
of Seattle Orthopedic Group, Inc.
(Manufacturing)
Ron May 54 President and Chief Operating Officer
of Southern Prosthetic Supply, Inc.
(Distribution)
Deneane M. Butler 36 Controller, Secretary and Treasurer
of the Company
- -------------------
Ivan R. Sabel has been Chairman of the Board and Chief Executive Officer
of Hanger since August 1995. He has been the President of Hanger since October
14, 1999, and also served as President from November 1987 to July 1, 1999. Mr.
Sabel also served as the Chief Operating Officer of Hanger from November 1987
to August 1995. Prior to that time, Mr. Sabel had been Vice President -
Corporate Development from September 1986 to November 1987. From 1968 until
joining Hanger in 1986, Mr. Sabel was the founder and President of Capital
Orthopedics, Inc. before that company was acquired by Hanger. Mr. Sabel is a
Certified Prosthetist and Orthotist ("CPO"), a member of the Board of
Directors of the American Orthotic and Prosthetic Association ("AOPA"), a
former Chairman of the National Commission for Health Certifying Agencies, a
former member of the Strategic Planning Committee and a current member of the
Veterans Administration Affairs Committee of AOPA and a former President of
the American Board for Certification in Orthotics and Prosthetics. Mr. Sabel
also serves on the Board of Directors of Mid-Atlantic Medical Services, Inc.,
a company engaged in the health care management services business.
15
Richmond L. Taylor was the Executive Vice President and Chief Operating
Officer of NovaCare O&P until July 1, 1999, when he became an Executive Vice
President of the Company and Chief Operating Officer of each of Hanger
Prosthetics & Orthotics, Inc. and HPO, Inc. the wholly-owned subsidiary of the
Company which operate all of our patient-care centers. Previously, Mr. Taylor
served as the Regional Vice President of NovaCare O&P for the West Region
since 1989. Prior to joining NovaCare, Mr. Taylor spent 20 years in the health
care industry in a variety of management positions including Regional Manager
at American Hospital Supply Corporation, Vice President of Operations at
Medtech, Vice President of Sales at Foster Medical Corporation and Vice
President of Sales at Integrated Medical Systems.
Dennis T. Currier was appointed interim Chief Financial Officer of Hanger
on January 23, 2001. Mr. Currier has over thirty years of experience in the
health care industry serving in both senior executive and consulting
capacities. Mr. Currier was a partner with one of the "big five" public
accounting firms and served as Chief Financial Officer of a large integrated
health care delivery system for over ten years.
James G. Cairns, Jr. has served as the President and Chief Operating
Officer of Seattle Orthopedic Group, Inc., a wholly-owned subsidiary of the
Company that designs, manufactures and distributes orthotic and prosthetic
products, since the Company's acquisition of Model and Instrument Development
Corporation in August 1998, of which he had served as the President and Chief
Executive Officer since 1992. Model and Instrument Development Corporation
operated under the trade name Seattle Limb Systems and manufactured prosthetic
components and related equipment. Previously, he served from 1987 to 1992 as
the Chairman of the Board and Chief Executive Officer of Alliance
Bancorporation, a bank holding company, and earlier as a consultant to the
financial services industry and in management positions with various banking
organizations.
Ron May has been the President and Chief Operating Officer of Southern
Prosthetic Supply, Inc., a wholly-owned subsidiary of the Company that
distributes orthotic and prosthetic products, since December 1998. From
January 1984 to December 1998, Mr. May was Executive Vice President of the
distribution division of J.E. Hanger, Inc. of Georgia, which we acquired in
November 1996.
Deneane M. Butler has served as the Vice President of Finance and
Controller of Hanger since September 1994 and as the Secretary and Treasurer
of the Company since January 23, 2001. Ms. Butler was also the Assistant
Controller of Hanger from April 1992 to September 1994 and was a Certified
Public Accountant.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
-------------------------------------------------
Our common stock has been listed and traded on the New York Stock
Exchange since December 15, 1998, under the symbol "HGR." The following table
sets forth the high and low intra-day sale prices for the common stock for the
periods indicated as reported on the New York Stock Exchange:
Year Ended December 31, 1999 High Low
---- ---
First Quarter $27.50 $12.00
Second Quarter 19.44 12.38
Third Quarter 15.00 10.50
Fourth Quarter 15.50 8.75
Year Ended December 31, 2000 High Low
---- ---
First Quarter $10.3125 $3.7500
Second Quarter 5.5000 3.7500
Third Quarter 4.8750 3.2500
Fourth Quarter 4.1875 0.9375
At March 29, 2001, there were approximately 807 holders of record of the
Company's Common Stock.
Dividend Policy
We have never paid cash dividends on our common stock and intend to
continue this policy for the foreseeable future. We plan to retain earnings
for use in our business. The terms of our agreements with our financing
sources and certain other agreements prohibit the payment of dividends on our
common stock and preferred stock and such agreements will continue to prohibit
the payment of dividends in the future. Any future determination to pay cash
dividends will be at the discretion of our Board of Directors and will be
dependent on our results of operations, financial condition, contractual and
legal restrictions and any other factors deemed to be relevant.
17
ITEM 6. SELECTED CONSOLIDATED FINANCIAL INFORMATION.
--------------------------------------------
The selected consolidated financial data presented below is derived from
the audited Consolidated Financial Statements and Notes thereto included
elsewhere in this report.
18
SELECTED FINANCIAL DATA
(In thousands, except per share data)
Years Ended December 31,
----------------------------------------------------------------
1996 1997 1998 1999 2000
---- ---- ---- ---- ----
Statement of Operations Data:
Net sales $ 66,806 $ 145,598 $ 187,870 $ 346,826 $ 486,031
Gross profit 34,573 72,065 94,967 177,750 234,663
Selling, general & administrative 24,550 49,076 63,512 113,643 177,519
Depreciation and amortization 2,848 4,681 5,782 14,058 23,328
Integration costs (1) 2,480 --- --- 5,035 1,710
Restructuring costs (1) --- --- --- 1,305 654
Income from operations 4,695 18,308 25,673 43,709 31,452
Interest expense, net (2,547) (4,933) (1,902) (22,177) (47,072)
Income (loss) before taxes,
extraordinary item 1,971 13,166 23,456 21,180 (15,493)
Provision (benefit) for income taxes 890 5,526 9,616 10,194 (1,497)
Income (loss) before
extraordinary item 1,081 7,640 13,840 10,986 (13,996)
Extraordinary loss on early
extinguishment of debt (83) (2,694) --- --- ---
Net income (loss) $ 998 $ 4,946 $ 13,840 $ 10,986 (13,996)
Basic per common share data:
Income (loss) before
extraordinary item $ 0.12 $ 0.65 $ 0.82 $ 0.47 $ (0.98)
Extraordinary loss on early
extinguishment of debt (0.01) (0.23) --- --- ---
Net income (loss) per common share $ 0.11 $ 0.42 $ 0.82 $ 0.47 $ (0.98)
===============================================================
Shares used to calculate basic per
common are amounts 8,470 11,793 16,813 18,855 18,910
===============================================================
Diluted per common share data (2):
Income (loss) before
extraordinary item $ 0.12 $ 0.58 $ 0.75 $ 0.44 $ (0.98)
Extraordinary loss on early
extinguishment of debt (0.01) (0.21) --- --- ---
Net income (loss) per common share $ 0.11 $ 0.37 $ 0.75 $ 0.44 $ (0.98)
===============================================================
Shares used to calculate diluted
per common share amounts 8,663 13,138 18,516 20,005 18,910
===============================================================
19
December 31,
------------
Balance Sheet Data: 1996 1997 1998 1999 2000
---- ---- ---- ---- ----
Cash and cash equivalents $ 6,572 $ 6,557 $ 9,683 $ 5,735 $ 20,669
Working capital 25,499 39,031 49,678 118,428 133,690
Total assets 134,941 157,983 205,948 750,081 761,818
Long-term debt 64,298 23,237 11,154 426,211 422,838
Shareholders' equity 39,734 106,320 162,553 172,914 154,380
(1) The 1996 results include acquisition and integration costs of $2.5
million incurred in connection with the purchase of J. E. Hanger,
Inc. of Georgia effective November 1, 1996. The 1999 and 2000
results include restructuring and integration costs of $6.3 million
and $2.4 million, respectively, incurred in connection with the
purchase of NovaCare O&P.
(2) For 1999 and 2000, excludes the effect of the conversion of the 7%
Redeemable Convertible Preferred Stock into Common Stock as it is
considered anti-dilutive. For 2000, excludes the effect of all
dilutive options and warrants as a result of the Company's net loss
for the year ended December 31, 2000.
Quarter Ended
-------------
1999 March 31 June 30 Sept. 30 Dec. 31
---- -------- ------- -------- -------
Net Sales 49,145 56,417 124,922 116,342
Gross Profit 24,256 28,862 65,344 59,288
Net Income (Loss) 3,121 4,875 3,449 (459)
Diluted Per Common Share
Data Net Income (1) $0.15 $0.24 $0.12 $(0.08)
2000 March 31 June 30 Sept. 30 Dec. 31
---- -------- ------- -------- -------
Net Sales 114,868 125,872 125,252 120,039
Gross Profit 57,684 65,562 64,430 46,987
Net Income (Loss) (2) (279) 2,407 1,596 (17,720)
Diluted Per Common Share
Data Net Income (1) $(0.07) $0.06 $0.02 $(0.99)
(1) For 1999 and 2000, excludes the effect of the conversion of the 7%
Redeemable Convertible Preferred Stock into Common Stock as it is
considered anti-dilutive. For 2000, excludes the effect of all
dilutive options and warrants as a result of the Company's net loss
for the year ended December 31, 2000.
20
(2) During the fourth quarter of 2000, the Company recorded charges of
approximately $9.6 million and $9.0 million related to an inventory
adjustment and an increase in the allowance for doubtful accounts
respectively. Management considers these charges to be changes in
estimates in accordance with the provisions of Accounts Principles
Board Opinion No. 20.
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
-------------------------------------------------
Overview
The significant growth in our net sales has resulted from an aggressive
program of acquiring and developing O&P patient-care centers. Similarly,
growth in our O&P distribution and manufacturing net sales is attributable
primarily to acquisitions. At December 31, 2000, the Company operated 620
patient-care centers, six distribution facilities and seven manufacturing
facilities.
Expansion
The following table sets forth the number of patient-care centers,
certified practitioners and states (including the District of Columbia) in
which we operated at the end of each of the past three years:
For the Years Ended December 31,
-----------------------------------------
1998 1999 2000
---- ---- ----
Number of patient-care centers.......... 256 617 620
Number of certified practitioners....... 321 962 888
Number of states (including D.C.)....... 31 42 45
Recent Acquisitions
During 2000, we acquired five O&P companies for an aggregate
consideration, excluding earn out provisions, of approximately $4.5 million,
consisting of approximately $2.4 million of cash and $2.1 million of
promissory notes. These O&P companies, which operated seven patient-care
centers at December 31, 2000, had combined net sales of approximately $2.3
million in the year ended December 31, 2000. Additional amounts aggregating
approximately $13.9 million may be paid in connection with earnout provisions
contained in acquisition agreements.
On July 1, 1999, we acquired NovaCare O&P for an aggregate consideration
of $445.0 million. NovaCare O&P, which operated 395 O&P patient care centers
at June 30, 1999, had net sales of approximately $278.8 million in the twelve
months ended June 30, 1999. We acquired five other O&P companies during 1999
for an aggregate consideration, excluding potential earn-out provisions, of
approximately $11.9 million. These O&P companies, which operated five
patient-care centers at December 31, 1999, had combined net sales of
approximately $10.5 million in the year ended December 31, 1998.
Sources of Net Sales
The majority of our net sales continue to be derived from operating
patient-care centers. The following table sets forth the percent contributed
to net sales in each of the periods indicated by the principal sources of our
net sales. The decrease in the percentage of net sales contributed by
22
distribution activities and decrease in the percentage of net sales
attributable to manufacturing in 1999 and 2000 is primarily a result of the
NovaCare O&P acquisition which consisted entirely of patient-care services.
For the Years Ended December 31,
------------------------------------------
1998 1999 2000
---- ---- ----
Source of net sales:
Patient-care services............ 81.1% 88.6% 92.0%
Manufacturing.................... 4.5 3.0 2.0
Distribution..................... 14.4 8.4 6.0
------ ------ ------
100.0% 100.0% 100.0%
====== ====== ======
Payor Mix (1):
We receive payments for O&P services rendered to patients from private
insurers, HMOs, PPOs, the patients directly and governmental payors, including
Medicare, Medicaid and the VA. The sources and amounts of our net sales
derived from patient-care centers are determined by a number of factors,
including the number and nature of O&P services rendered and the rates of
reimbursement among payor categories. Generally, private insurance and other
third-party reimbursement levels are greater than managed care (HMO/PPO),
Medicare, Medicaid and VA reimbursement levels. Changes in our payor mix can
affect our profitability. The following table sets forth the percent
contributed to net sales in each of the following periods by the principal
categories of payors:
For the Years Ended December 31,
-----------------------------------------
1998 1999 2000
---- ---- ----
Payor mix (1):
Private pay and other............. 46.3% 59.0% 61.6%
Medicare/Medicaid/VA/state
Agencies....................... 53.7 41.0 38.4%
------ ----- -----
100.0% 100.0% 100.0%
====== ====== ======
(1) Payor mix data is based on a sampling of approximately 41% of the
patient-care centers in 1998, approximately 79% of the patient care
centers in 1999 and approximately 84% of the patient care centers
in 2000.
23
Adjusted EBITDA and Operating Margin Trends
Adjusted EBITDA and operating margins in 2000 were lower than 1999,
primarily as a result of (i) higher material cost of goods sold, (ii)
increased provision for bad debt expense and (iii) higher general and
administrative costs. In 1999, margins were higher than 1998, primarily as a
result of (i) the acquisition of NovaCare O&P which was entirely patient care
services, which historically have experienced higher margins than distribution
and manufacturing operations; and (ii) the elimination of duplicative overhead
and corporate field personnel. The following table sets forth our Adjusted
EBITDA and operating margins during each of the past three years:
For the Years Ended December 31,
-----------------------------------
1998 1999 2000
---- ---- ----
Adjusted EBITDA margin (1)......... 16.7% 18.5% 11.8%
Operating margin (2)............... 13.7 12.6 6.5
(1) Adjusted "EBITDA" is defined as net income (loss) before interest
expense (net), taxes, depreciation and amortization, discontinued
operations, restructuring and integration costs, other expense
(net), extraordinary items and accounting change. Adjusted EBITDA
is not a measure of performance under GAAP. While Adjusted 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
Adjusted EBITDA is customarily used as a criteria in evaluating
health care companies and is a common metric used by lenders in
debt covenants.
(2) "Operating" is defined as net income (loss) before interest expense,
taxes and discontinued operations.
Seasonality
Our results of operations are affected by seasonal considerations. The
adverse weather conditions often experienced in certain geographical
areas of the United States during the first quarter of each year,
together with a greater degree of patients' sole responsibility for their
insurance deductible payment obligations during the beginning of each
calendar year, have contributed to lower net sales during that quarter.
Results of Operations
The following table sets forth for the periods indicated certain items of
our statements of operations as a percentage of our net sales:
24
For the Years Ended December 31,
----------------------------------
1998 1999 2000
---- ---- ----
Net sales............................................ 100.0% 100.0% 100.0%
Cost of products & services sold..................... 49.5 48.7 51.7
Gross profit......................................... 50.5 51.3 48.3
Selling, general and administrative.................. 33.8 32.8 36.5
Depreciation and amortization........................ 1.7 1.9 2.3
Amortization of excess cost over net
Assets acquired................................. 1.3 2.2 2.5
Integration and restructuring costs.................. -- 1.8 .5
Income (loss) from operations........................ 13.7 12.6 6.5
Interest expense, net................................ 1.0 6.4 9.7
Income (loss) before taxes and extraordinary
Item............................................ 12.5 6.1 (3.2)
Income taxes......................................... 5.1 2.9 (0.3)
Net income........................................... 7.4 3.2 (2.9)
Year Ended December 31, 2000 Compared to the Year Ended December 31, 1999
- -------------------------------------------------------------------------
Net Sales. Net sales for the year ended December 31, 2000, were
approximately $486.0 million, an increase of approximately $139.2 million, or
40.1%, over net sales of approximately $346.8 million for the year ended
December 31, 1999. The increase was principally attributable to the
acquisition of NovaCare O&P on July 1, 1999.
Gross Profit. Gross profit in the year ended December 31, 2000 was
approximately $234.7 million, an increase of approximately $56.9 million, or
32.0%, from gross profit of approximately $177.8 million for the year ended
December 31, 1999. Gross profit as a percentage of net sales decreased to
48.3% in 2000 from 51.3% in 1999. This decrease in the gross profit margin is
primarily attributable to higher material costs and changes in product mix.
Selling, General and Administrative. Selling, general and administrative
expenses in the year ended December 31, 2000 increased by approximately $63.9
million, or 56.2%, compared to the year ended December 31, 1999. Selling,
general and administrative expenses as a percentage of net sales increased to
36.5% in 2000 compared to 32.8% in 1999. The increase in selling, general and
administrative expenses was primarily due to the NovaCare O&P acquistion on
July 1, 1999 and primarily occurred in payroll, rent and bad debt expense.
Integration and Restructuring Costs. During the year ended December 31,
2000, we recognized approximately $2.4 million of one-time integration costs
in connection with our acquisition on July 1, 1999 of NovaCare O&P, a
substantial decrease from the $6.3 million of integration and restructuring
costs recognized in the prior year. Additional information relating to
integration and restructuring costs is set forth below under "Integration and
Restructuring Costs."
25
Income from Operations. Principally as a result of the above, income from
operations in 2000 was approximately $31.5 million, a decrease of $12.2
million, or 27.9%, from the prior year. Income from operations as a percentage
of net sales decreased to 6.5% in 2000 from 12.6% for the prior year.
Interest Expense, Net. Net interest expense for the year ended December
31, 2000 was approximately $47.1 million, an increase of approximately $24.9
million over approximately $22.2 million incurred in 1999. Interest expense as
a percentage of net sales in 2000 increased to 9.7% from 6.4% for 1999. The
increase in interest expense was primarily attributable to $255.0 million
borrowed under a bank credit facility and $150 million in senior subordinated
notes issued to acquire NovaCare O&P, as well as an increase in variable
borrowing rates.
Income Taxes. Our effective tax rate benefit was 9.7% in 2000 versus a
provision of 48% in 1999. The decrease in the effective tax rate in 2000 was a
result of the operating and taxable losses incurred during the year. The
benefit from income taxes for the year ended December 31, 2000 was
approximately $1.5 million compared to provision for income taxes of
approximately $10.2 million for the year ended December 31, 1999.
Net Income/Loss. As a result of the above, we reported a net loss of
approximately $14.0 million, or $.98 per common dilutive share (loss), for the
year ended December 31, 2000, as compared to net income of $11.0 million, or
$.44 per common dilutive share, for the year ended December 31, 1999.
Year Ended December 31, 1999 Compared to the Year Ended December 31, 1998
------------------------------------------------------------------------
Net Sales. Net sales for the year ended December 31, 1999 were
approximately $346.8 million, an increase of approximately $159.0 million, or
84.6%, over net sales of approximately $187.9 million for the year ended
December 31, 1998. Contributing to the increase was the acquisition of
NovaCare O&P on July 1, 1999.
Gross Profit. Gross profit for the year ended December 31, 1999, was
approximately $177.8 million, an increase of approximately $82.8 million, or
87.2%, over gross profit of approximately $95.0 million for the year ended
December 31, 1998. The increase was primarily attributable to the increase in
net sales. Gross profit as a percentage of net sales increased to 51.3% in
1999 from 50.5% in 1998. The increase in the gross profit margin is primarily
a result of the NovaCare O&P acquisition which was entirely patient care
services. Patient care services historically have experienced higher gross
profit margins than distribution and manufacturing operations.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses in the year ended December 31, 1999 increased by
approximately $50.1 million, or 78.9%, compared to the year ended December 31,
1998. Selling, general and administrative expenses as a percentage of net
sales in 1999 decreased to 32.8% from 33.8% in 1998.
Integration and Restructuring Costs. As stated above, we recognized
approximately $6.3 million of integration and restructuring costs during 1999
in connection with our acquisition on July 1, 1999 of NovaCare O&P. Additional
information relating to the integration and restructuring costs is set forth
below under "Integration and Restructuring Costs."
Income from Operations. Principally as a result of the above, income from
operations in the year ended December 31, 1999 was approximately $43.7
million, an increase of approximately $18.0 million, or 70.3%, over the prior
26
year's comparable period. Income from operations as a percentage of net sales
decreased to 12.6% in 1999 from 13.7% in 1998.
Interest Expense, Net. Interest expense, net for the year ended December
31, 1999 was approximately $22.2 million, an increase of approximately $20.3
million over approximately $1.9 million incurred in the year ended December
31, 1998. Interest expense as a percentage of net sales increased to 6.4% from
1.0% for the prior year. The increase in interest expense was primarily
attributable to $255.0 million borrowed under a bank credit facility and
$150.0 million in senior subordinated notes issued to acquire NovaCare O&P.
Income Taxes. Our effective tax rate was 48% in 1999 versus 41% in 1998.
The increase in 1999 is a result of the disproportionate impact of the
amortization of the excess costs over net assets acquired in relation to
taxable income, primarily attributable to the acquisition of NovaCare O&P. The
provision for income taxes for the year ended December 31, 1999 was
approximately $10.2 million compared to approximately $9.6 million for the
year ended December 31, 1998.
Net Income/Loss. As a result of the above, we recorded net income of
approximately $11.0 million, or $.44 per dilutive common share, in the year
ended December 31, 1999, compared to net income of approximately $13.8
million, or $.75 per dilutive common share, in 1998. Net income for 1999,
excluding the integration and restructuring costs, would have been $14.8
million, or $.63 per dilutive common share.
Liquidity and Capital Resources
Cash flow generated from operating activities during 2000 approximated
$3.6 million, an increase of $3.8 million from the 1999 level of cash flow
used for operating activities of $224.0. The increase resulted from a
reduction in the rate of working capital investment growth (i.e., although
working capital increased in absolute terms during 2000, it did so at a
considerably lower rate than experienced in 1999), offset by lower cash
earnings. Cash earnings, defined as Adjusted EBITDA less interest expense,
restructuring and integration costs and current income tax expense, decreased
approximately $20 million from $26.1 million in 1999 to $6 million in 2000.
Cash flow used for operating activities during 1999 of $224,000 represented a
decrease in operating cash flows of approximately $18.8 million from the 1998
level of cash flow generated by operating activities of $18.5 million. This
decrease principally resulted from an increase in the investment of working
capital during 1999, offset by an increase in cash earnings of approximately
$6.7 million during 1999.
The comparability of cash flows used for investing and financing
activities for each of the years in the three year period ended December 31,
2000 is largely impacted by the Company's acquisition of the NovaCare O&P from
NovaCare, Inc on July 1, 1999 (the "Acquisition").
Under the terms of the Acquisition agreement, the aggregate purchase
price consideration totaled $445.0 million, which consisted of the assumption
of liabilities and other obligations of $38.4 million and the balance in cash.
Of the cash portion, $15.0 million was placed in escrow pending the
determination of any potential post closing adjustments relating to working
capital. During 2000, the Company received $24.7 million from NovaCare, Inc.
pursuant to the post closing purchase price adjustment. Reference is made to
the discussion under "Arbitration of Dispute Regarding Adjusted Working
Capital of NovaCare O&P and Subsequent Litigation" below for information
regarding post-closing adjustments.
27
Hanger required approximately $430.2 million in cash to close the
acquisition, to pay approximately $20.0 million of related fees and expenses,
including debt issue costs of approximately $16.0 million, and to refinance
existing debt of approximately $2.5 million. The funds were raised by Hanger
through (i) borrowing approximately $230.0 million of revolving credit and
term loans under a new bank facility; (ii) selling $150.0 million principal
amount of 11.25% Senior Subordinated Notes due 2009; and (iii) selling $60.0
million of 7% Redeemable Preferred Stock. The new bank credit facility
consists of a $100.0 million revolving credit facility, of which $30.0 million
was drawn on in connection with the acquisition of NovaCare O&P, a $100
million Tranche A term facility and a $100 million Tranche B term facility.
The Company's consolidated liquidity position (comprised of cash and cash
equivalents and unused credit facilities) approximated $36 million at December
31, 2000 compared to approximately $50.7 million at December 31, 1999.
Consolidated working capital at December 31, 2000 of approximately $133.7
million is up $15.3 million from the December 31, 1999 level of $118.4
million.
The Company's total long term debt at December 31, 2000, including a
current portion of approximately $37.6 million, was approximately $460.4
million. Such indebtedness included: (i) $150.0 million of 11.25% million
Senior Subordinated Notes due 2009; (ii) $84.7 million for the Revolving
Credit Facility; (iii) $92.5 million for Tranche A Term Facility; (iv) $99.3
million for Tranche B Term Facility; and (v) a total of $33.9 million of other
indebtedness. The Revolving Credit Facility, and the Tranche A and B Term
Facilities (the "Credit Facility") were entered into with The Chase Manhattan
Bank, Bankers Trust Company, Paribas and certain other banks (the "Banks") in
connection with the Acquisition. The Revolving Credit Facility matures on July
1, 2005; the Tranche A Term Facility is payable in quarterly installments of
$5.0 million through July 1, 2005; and the Tranche B Term Facility is payable
in quarterly installments of $250,000 through December 31, 2004 and in
quarterly installments of $15.8 million through January 1, 2007.
The Credit Facility contains certain affirmative and negative covenants
customary in an agreement of this nature. At December 31, 1999, the Company
was not in compliance with financial covenants under the Credit Facility for
capital expenditure and adjusted interest coverage ratio. In consideration for
the Banks' waiver of the Company's non-compliance with these covenants, an
amendment to the Credit Agreement effective March 29, 2000 was entered into
which provided for an increase in the interest rates of the Credit Facility
borrowings by 25 basis points. Certain of the financial covenants were eased
with respect to 2000 and 2001 under the terms of the amendment to the Credit
Agreement. In addition at December 31, 2000, the Company was not in compliance
with the financial covenants under the Credit Agreement for interest coverage
and leverage coverage. In consideration for the bank's waiver of the Company's
non-compliance with these covenants, an amendment to the amended and restated
Credit Agreement dated as of March 16, 2001 was entered into which provides
for an increase in the interest rates of the Credit Facility borrowings by 50
basis points. Certain of the financial covenants were eased with respect to
2001 and 2002 under the terms of the amendment to the Credit Agreement.
Matters critical to the Company's compliance with the Credit Facility's
covenants, and ultimately its immediate term liquidity (to the extent
alternative sources of liquidity are not readily available), include improving
operating results, through revenue growth and cost control, and reducing the
Company's investment in working capital. As further discussed below, the
Company has retained the services of Jay Alix & Associates to assist in
identifying programs aimed at achieving these objectives. The Company's
ability to continue to comply with the Credit Facility covenants is dependent
on certain factors, including (a) the ability of the Company to effectuate the
28
restructuring initiatives referred to above, and (b) the Company's ability to
continue to attract and retain experienced management and O&P practitioners.
Unexpected increases in the LIBOR rate could also adversely impact the
Company's ability to comply with the Credit Facility's covenants. Management
believes that the Company will continue to comply with the terms of the Credit
Facility and that the Company's consolidated liquidity position is adequate to
meet its short term and long term obligations.
The Credit Facility is collateralized by substantially all of the
Company's assets, restricts the payment of dividends and restricts the Company
from pursuing acquisition opportunities for the calendar year 2001.
All or any portion of outstanding loans under the Credit Facility may be
repaid at any time and commitments may be terminated in whole or in part at
our option without premium or penalty, except that LIBOR-based loans may only
be repaid at the end of the applicable interest period. Mandatory prepayments
will be required in the event of certain sales of assets, debt or equity
financings and under certain other circumstances.
The $60.0 million outstanding shares of 7% Redeemable Preferred Stock are
convertible into shares of our non-voting common stock at a price of $16.50
per share, subject to adjustment. The Company is entitled to require that the
7% Redeemable Preferred Stock be converted into non-voting common stock on and
after July 2, 2002, if the average closing price of the common stock for 20
consecutive trading days is equal to or greater than 175% of the conversion
price. The 7% Redeemable Preferred Stock will be mandatorily redeemable on
July 1, 2010 at a redemption price equal to the liquidation preference plus
all accrued and unpaid dividends. In the event of a change in control, the
Company must offer to redeem all of the outstanding 7% Redeemable Preferred
Stock at a redemption price equal to 101% of the sum of the per share
liquidation preference thereof plus all accrued and unpaid dividends through
the date of payment. The 7% Redeemable Preferred Stock accrues annual
dividends, compounded quarterly, equal to 7%, is subject to put rights and
will not require principal payments prior to maturity on July 1, 2010.
Agreement with Jay Alix & Associates
On December 11, 2000, the Company retained the services of JA&A to assist
in identifying areas for cash generation and profit improvement. Subsequent to
the completion of this diagnostic phase, the Company modified and extended the
retention agreement on January 23, 2001 to include the implementation of
certain restructuring activities. Among the targeted plans are spending
reductions, improving the utilization and effectiveness of support services,
including claims processing, the refinement of materials purchasing and
inventory management and the consolidation of distribution services. In
addition, the Company will seek to enhance revenues through revised marketing
efforts and more efficient billing procedures.
The terms of this engagement provide for payment of JA&A's normal hourly
fees plus a success fee if certain defined benefits are achieved. Management
has elected to pay one-half of any earned success fees in cash, with the
remaining one-half of the success fee paid through a grant of options to
purchase the Company's stock. All the options will be granted with an exercise
price of $1.40 per share, which was the average closing price of the Company's
common stock for all trading days during the period from December 23, 2000 -
January 23, 2001. The number of options will be determined by multiplying the
non-cash half of each success fee invoice of JA&A by 1.5 and dividing the
product by $1.40. The options are to be granted within 30 days of each
29
invoice, shall be exercisable beginning with the sixth month following each
award and shall expire five years from the termination of JA&A's engagement.
The number of options that will be granted cannot be determined at this time.
Integration and Restructuring Costs
In December of 2000, management and the Board of Directors determined
that major performance improvement initiatives needed to be adopted. Two
hundred and thirty-four (234) employees were severed, resulting in a charge of
approximately $1.0 million (the amount is offset by approximately $381,000
restructuring benefit described below), and in December 2000 the Company
retained JA&A to do an assessment of the opportunities available for improved
financial and operating performance. JA&A was retained to develop a
comprehensive performance improvement program. The plan developed by JA&A and
the Company calls for a $30.0 million reduction in operating expenses over a
two year period, significant increases in patient revenue and reductions in
inventory and accounts receivable levels. The plan calls for the incurrence of
one-time, non-recurring costs of nearly $9.0 million during 2001. The
performance improvement plan was provided to the secured lenders on February
23, 2001 and calls for formal quarterly status reports to the Hanger Board and
lenders. As of December 31, 2000, the Company recorded approximately $693,000
in restructuring liabilities. Those amounts were paid in January of 2001, thus
completing the plan of restructuring.
The above restructuring charges and the related cost savings represent
our best estimate, but necessarily make numerous assumptions with respect to
industry performance, general business and economic conditions, raw materials
and product pricing levels, government legislation, the timing of
implementation of the restructuring and related employee reductions and
patient-care center closings and other matters, many of which are outside of
our control. Our estimate of cost savings is not necessarily indicative of
future performance, which may be significantly more or less favorable than as
set forth and is subject to the considerations relating to forward-looking
statements that are set forth below under the caption "Forward Looking
Statements."
The Company has implemented a plan of restructuring relating to our
acquisition of NovaCare O&P on July 1, 1999. The plan contemplated lease
termination and severance costs associated with the closure of certain
redundant patient-care centers and corporate functions. The Company has
transitioned patients being cared for at a closed patient-care center to
another patient-care center generally located within proximity to the closed
branch. During 1999 we recorded approximately $5.6 million in restructuring
liabilities for the costs associated with the restructuring of the NovaCare
O&P operations and allocated such costs to the purchase price of NovaCare O&P
in accordance with purchase accounting requirements. Also during 1999 and
2000, The Company accrued approximately $1.3 million and $0.7 million
respectively, for the costs associated with the restructuring of our
operations.
The 1999 restructuring plan provided for the closure of 54 patient-care
centers, consisting of 29 Hanger and 25 NovaCare O&P locations, and the
termination of the employment of 225 employees. As of December 31, 2000, all
of the reduction in force had been completed. Management decided to amend the
original restructuring plan which called for the closure of 54 patient care
centers. As of December 31, 2000, 44 of the patient care centers were closed
and management reversed approximately $672,000 of the restructuring reserve
providing an approximate restructuring benefit during fourth quarter 2000 of
$381,000 and a reduction of goodwill of approximately $291,000.
30
We also have expensed integration costs relating to the integration of
the acquired NovaCare O&P patient-care centers. During 1999 and 2000, we
expensed approximately $5.0 million and $1.7 million, respectively, of
integration costs. Such integration costs include costs of changing
patient-care center names, payroll and related benefits conversion costs,
stay-paid bonuses and related benefits for transitional employees and certain
other costs relating to the acquisition. Integration costs are expensed as
incurred.
Arbitration of Dispute Regarding Adjusted Working Capital of NovaCare O&P and
Subsequent Litigation
As stated above, on July 1, 1999, we acquired all of the outstanding
capital stock of NovaCare O&P from NovaCare, Inc. pursuant to a Stock Purchase
Agreement, dated April 2, 1999 and amended on May 19, 1999 and June 30, 1999,
by and among NovaCare, NC Resources, Inc., Hanger and HPO Acquisition
Corporation. The purchase price paid by us was $445.0 million, subject to
adjustment to the extent that NovaCare O&P's adjusted working capital at June
30, 1999 was less or greater than $92.0 million. Of the purchase price paid by
us, $15.0 million was placed in escrow with U.S. Bank Trust National
Association, as exchange agent, pending the determination of such amount of
adjusted working capital. We and NovaCare disagreed regarding the
determination of the amount of NovaCare O&P adjusted working capital and on
February 25, 2000, we and NovaCare submitted the matter to the independent
arbitrator in accordance with the dispute resolution arbitration mechanism
provided under the Stock Purchase Agreement. The agreement provided that such
arbitrator's determination would be conclusive and binding upon the parties.
On May 22, 2000, the independent arbitrator issued its report concluding
that NovaCare O&P's adjusted working capital at June 30, 1999 was
approximately $68.9 million and that we were entitled to the working capital
deficiency of approximately $25.1 million, representing the required decrease
in the purchase price previously paid by us for NovaCare O&P. On May 25, 2000,
the escrow agent released the $15.0 million of escrowed funds to us. Pursuant
to the Stock Purchase Agreement, we were entitled to receive the approximately
$10.1 million balance of the working capital deficiency on or before June 21,
2000, which was 30 days after the date of the independent arbitrator
determination.
On June 5, 2000, NovaCare (the name of which was changed to NAHC, Inc.)
filed a Complaint in the Court of Chancery of the State of Delaware in and for
New Castle County against us, our subsidiary, HPO Acquisition Corp., and the
escrow agent alleging the wrongful release of the escrowed funds and seeking
the return of such escrowed funds to the Escrow Agent. On June 9, 2000, we
filed an answer and counterclaim requesting the Court to dismiss the Complaint
and confirm the entire independent arbitrator award.
On June 30, 2000, we entered into a Settlement Agreement with NovaCare
providing for dismissal of the litigation and execution of a mutual release
relating to currently unknown matters arising from the acquisition. In
addition, the Settlement Agreement provided that of the $10.1 million owed by
NovaCare to us, $6.0 million would be paid immediately by NovaCare and
NovaCare would execute a collateralized promissory note in the principal
amount of $3.7 million, plus 7% annual interest, payable monthly over the
following six months. Actual payment of the $6.0 million was received by us on
July 3, 2000. In connection with the settlement, we were confident that we
would have prevailed in the litigation. However, in view of the time that
31
would have been involved in obtaining a favorable result and NovaCare's
inability to pay the full $10.1 million at the time the Settlement Agreement
was entered into, we determined it would be prudent to enter into such
agreement, under which we gave NovaCare a $0.4 million discount in exchange
for the immediate payment of $6.0 million and the greater certainty of
receiving $3.7 million under the promissory note. The $3.7 million was
received in a timely manner with some minor deductions relating to certain
other outstanding accounts payable between the parties.
Class Action
On November 28, 2000, a class action complaint (Norman Ottmann v. Hanger
Orthopedic Group, Inc., Ivan R. Sabel and Richard A. Stein; Civil Action No.
00CV3508) was filed against us in the United States District Court for the
District of Maryland on behalf of all purchasers of our common stock from
November 8, 1999 through and including January 6, 2000. The complaint also
names as defendants Ivan R. Sabel, our Chairman of the Board, President and
Chief Executive Officer, and Richard A. Stein, our former Chief Financial
Officer, Secretary and Treasurer.
The complaint alleges that during the above period of time, the
defendants violated Section 10(b) and 20(a) of the Securities Exchange Act of
1934 by, among other things, knowingly or recklessly making material
misrepresentations concerning our financial results for the quarter ended
September 30, 1999, and the progress of our 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 our common stock. The plaintiff seeks to recover damages
on behalf of all of the class members.
We believe that the allegations have absolutely no merit and plan to
vigorously defend the lawsuit.
New Accounting Standards
In June 1998, the Financial Accounting Standard Board issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for fiscal years beginning after June 15, 2000. SFAS 133 requires
that an entity recognize all derivative instruments as either assets or
liabilities on its balance sheet at their fair value. Changes in the fair
value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part
of a hedge transaction, and, if it is, the type of hedge transaction. The
Company has adopted SFAS 133 as of January 1, 2001. As the Company does not
use derivative instruments SFAS 133 did not have a material effect on the
financial position or resutls of operation of the Company at January 1, 2001.
In December 1999, the of the Securities and Exchange Commission released
Staff Accounting Bulletin No. 101 ("SAB 101"). "Revenue Recognition," to
provide guidance on the recognition, presentation and disclosure of revenue in
financial statements. The Company believes that its revenue recognition
practices are in conformity with the guidelines in SAB 101, as revised, and
that this pronouncement will have no material impact on its financial
statements.
In March 2000, the Financial Accounting Standards Board ("FASB") released
Interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation: an interpretation of APB Opinion No. 25." Interpretation No. 44
provided clarification of certain issues, such as determination of who is an
employee, the criteria for determining whether a plan qualifies as a
non-compensatory plan, the accounting consequence of various modifications to
32
the terms of a previously fixed stock option or award and the accounting for
an exchange of stock compensation awards in a business combination. The
Company believes that its practices are in conformity with this guidance, and
therefore Interpretation No. 44 has no impact on its financial statements.
In 2000, the FASB issued SFAS No. 137, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" (which was
amended by SFAS 140). This statement replaces SFAS No. 125 (of the same name).
SFAS No. 140 carries over the main provisions of SFAS No. 125 concerning and
servicing of Financial Assets. At December 31, 2000, this standard would not
have impacted the Company's financial statements.
Other
Inflation has not had a significant effect on our operations, as
increased costs to us generally have been offset by increased prices of
products and services sold.
We primarily provide services and customized devices throughout the
United States and are reimbursed, in large part, by the patients' third-party
insurers or governmentally funded health insurance programs. The ability of
our debtors to meet their obligations is principally dependent upon the
financial stability of the insurers of our patients and future legislation and
regulatory actions.
Forward Looking Statements
This report contains forward-looking statements setting forth our beliefs
or expectations relating to future revenues. Actual results may differ
materially from projected or expected results due to changes in the demand for
our O&P services and products, uncertainties relating to the results of
operations or recently acquired and newly acquired O&P patient care practices,
our ability to successfully integrate the operations of NovaCare O&P and to
attract and retain qualified O&P practitioners, governmental policies
affecting O&P operations and other risks and uncertainties affecting the
health-care industry generally. Readers are cautioned not to put undue
reliance on forward-looking statements. We disclaim any intent or obligation
to up-date publicly these forward-looking statements, whether as a result of
new information, future events or otherwise.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
-----------------------------------------------------------
In the normal course of business, we are exposed to fluctuations in
interest rates. We address this risk by using interest rate swaps from time to
time. At December 31, 2000 there were no interest rate swaps outstanding.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
-------------------------------------------
The consolidated financial statements and schedules required hereunder
and contained herein are listed under Item 14(a) below.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
------------------------------------------------
None.
33
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
--------------------------------------------------
Pursuant to General Instruction G(3) of Form 10-K, the information called
for by this item regarding directors is hereby incorporated by reference from
our definitive proxy statement or amendment hereto to be filed pursuant to
Regulation 14A not later than 120 days after the end of the fiscal year
covered by this report. Information regarding our executive officers is set
forth under Item 4A of this Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION.
----------------------
Pursuant to General Instruction G(3) of Form 10-K, the information called
for by this item is hereby incorporated by reference from our definitive proxy
statement or amendment hereto to be filed pursuant to Regulation 14A not later
than 120 days after the end of the fiscal year covered by this report.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.
---------------------------------------------------
Pursuant to General Instruction G(3) of Form 10-K, the information called
for by this item is hereby incorporated by reference from our definitive proxy
statement or amendment hereto to be filed pursuant to Regulation 14A not later
than 120 days after the end of the fiscal year covered by this report.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
-----------------------------------------------
Pursuant to General Instruction G(3) of Form 10-K, the information called
for by this item is hereby incorporated by reference from our definitive proxy
statement or amendment hereto to be filed pursuant to Regulation 14A not later
than 120 days after the end of the fiscal year covered by this report.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON
FORM 8-K.
------------------------------------------------------
(a) Financial Statements and Financial Statement Schedule:
------------------------------------------------------
(1) Financial Statements:
---------------------
Hanger Orthopedic Group, Inc.
----------------------------
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1999
and 2000
Consolidated Statements of Operations for the years
ended December 31, 1998, 1999 and 2000
34
Consolidated Statements of Changes in Shareholders'
Equity for the years ended December 31,
1998, 1999 and 2000
Consolidated Statements of Cash Flows for the years
ended December 31, 1998, 1999 and 2000
Notes to Consolidated Financial Statements
(2) Financial Statements Schedule:
------------------------------
Report of Independent Accountants
Schedule II - Valuation and qualifying accounts
All other schedules are omitted either because they are not applicable or
required, or because the required information is included in the financial
statements or notes thereto:
(b) Reports on Form 8-K:
No Forms 8-K were filed during the quarter ended December
31, 2000.
(c) Exhibits: The following exhibits are filed herewith or
incorporated herein by reference:
Exhibit No. Document
- ----------- --------
3(a) Certificate of Incorporation, as amended, of the
Registrant. (Incorporated herein by reference to
Exhibit 3.1 to the Registrant's Annual Report on
Form 10-K for the fiscal year ended September 30,
1988.)
3(b) Certificate of Amendment of the Registrant's
Certificate of Incorporation (which, among other
things, changed the Registrant's corporate name
from Sequel Corporation to Hanger Orthopedic Group,
Inc.), as filed on August 11, 1989 with the Office
of the Secretary of State of Delaware.
(Incorporated herein by reference to Exhibit 3(b)
to the Registrant's Current Report on Form 10-K
dated February 13, 1990.)
3(c) Certificate of Agreement of Merger of Sequel
Corporation and Delaware Sequel Corporation.
(Incorporated herein by reference to Exhibit 3.1(a)
to the Registrant's Annual Report on Form 10-K for
the fiscal year ended September 30, 1988.)
3(d) Certificate of Ownership and Merger of Hanger
Acquisition Corporation and J. E. Hanger, Inc. as
filed with the Office of the Secretary of the State
of Delaware on April 11, 1989.
35
(Incorporated herein by reference to Exhibit 2(f)
to the Registrant's Current Report on Form 8-K
dated May 15, 1989.)
3(e) Certificate of Designation, Preferences and Rights of
Preferred Stock of the Registrant as filed on
February 12, 1990 with the Office of the Secretary
of State of Delaware. (Incorporated herein by
reference to Exhibit 3(a) to the Registrant's
Current Report on Form 8-K dated February 13,
1990.)
3(f) Certificate of Amendment to Certificate of
Incorporation of the Registrant, as filed with the
Secretary of State of Delaware on September 16,
1999. (Incorporated herein by reference to Exhibit
3 to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1999.)
3(g) Certificate of Designation, Rights and Preferences of
7% Redeemable Preferred Stock as filed with the
Office of the Secretary of State of Delaware on
June 28, 1999. (Incorporated herein by reference to
Exhibit 2(b) to the Registrant's Current Report of
Form 8-K dated July 1, 1999.)
3(h) Certificate of Elimination of Class A, B, C, D, E and
F Preferred Stock of the Registrant as filed with
the Office of the Secretary of State of Delaware on
June 18, 1999. (Incorporated herein by reference to
Exhibit 2(c) to the Registrant's Current Report on
Form 8-K dated July 1, 1999.)
3(i) By-Laws of the Registrant, as amended. (Incorporated
herein by reference to Exhibit 3 to the
Registrant's Current Report on Form 8-K dated May
15, 1989.)
10(a) Registration Agreement, dated May 15, 1989, between
Sequel Corporation, First Pennsylvania Bank, N.A.,
Gerald E. Bisbee, Jr., Ivan R. Sabel, Richard A.
Stein, Ronald J. Manganiello, Joseph M. Cestaro and
Chemical Venture Capital Associates. (Incorporated
herein by reference to Exhibit 10(l) to the
Registrant's Current Report on Form 8-K dated May
15, 1989.)
10(b) First Amendment dated as of February 12, 1990, to the
Registration Agreement, dated as of May 15, 1989,
by and among Hanger Orthopedic Group, Inc., First
Pennsylvania Bank, N.A., Ivan R. Sabel, Richard A.
Stein, Ronald J. Manganiello, Joseph M. Cestaro and
Chemical Venture Capital Associates. (Incorporated
herein by reference to Exhibit 10(m) to the
Registrant's Current Report on Form 8-K dated
February 13, 1990.)
10(c) Fifth Amendment, dated as of November 8, 1990, to the
Stock and Note Purchase Agreement, dated as of
February 28, 1989 and as amended on May 9, 1989,
May 15, 1989, February 12, 1990, and June 19, 1990
by and among J. E. Hanger, Inc., as successor to
Hanger Acquisition Corporation, Ronald J.
Manganiello, Joseph M. Cestaro, Chemical Venture
Capital Associates and Chemical Equity Associates.
(Incorporated herein by reference to Exhibit 10(f)
to the Registrant's Current Report on Form 8-K
filed on November 21, 1990.)
36
10(d) Form of Stock Option Agreements, dated as of August
13, 1990, between Hanger Orthopedic Group, Inc. and
Thomas P. Cooper, James G. Hellmuth, Walter F.
Abendschein, Jr., Norman Berger, Bruce B. Grynbaum
and Joseph S. Torg. (Incorporated herein by
reference to Exhibit 10(rrr) to the Registrant's
Registration Statement on Form S-2, File No.
33-37594.) *
10(e) Warrants to purchase Common Stock of Hanger
Orthopedic Group, Inc. issued November 1, 1996.
(Incorporated herein by reference to Exhibit 10(c)
to the Registrant's Current Report on Form 8-K
filed on November 12, 1996.)
10(f) 1991 Stock Option Plan of the Registrant, as amended
through September 16, 1999. (Incorporated herein by
reference to Exhibit 4(a) to the Registrant's Proxy
Statement, dated July 28, 1999, relating to the
Registrant's Annual Meeting of Stockholders held on
September 8, 1999.)*
10(g) 1993 Non-Employee Directors Stock Option Plan of the
Registrant. (Incorporated herein by reference to
Exhibit 4(b) to the Registrant's Registration
Statement on Form S-8 (File No. 33-63191).)*
10(h) Employment and Non-Compete Agreement, dated as of
November 1, 1996, and Amendment No. 1 thereto,
dated January 1, 1997, between the Registrant and
H.E. Thranhardt. (Incorporated herein by reference
to Exhibit 10(p) to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1997.)
10(i) Employment and Non-Compete Agreement, dated as of
November 1, 1996, between the Registrant and John
McNeill. (Incorporated herein by reference to
Exhibit 10(q) to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1997.)
10(j) Asset Purchase Agreement, dated as of March 26, 1997,
by and between Hanger Prosthetics & Orthotics,
Inc., Acor Orthopaedic, Inc., and Jeff Alaimo, Greg
Alaimo and Mead Alaimo. (Incorporated by reference
to Exhibit 2 to the Current Report on Form 8-K
filed by the Registrant on April 15, 1997.)
10(k) Asset purchase Agreement, dated as of May 8, 1997, by
and between Hanger Prosthetics & Orthotics, Inc.,
Fort Walton Orthopedic, Inc., Mobile Limb and
Brace, Inc. and Frank Deckert, Ronald Deckert,
Thomas Deckert, Robert Deckert and Charles Lee.
(Incorporated by reference to Exhibit 2 to the
Current Report on Form 8-K filed by the Registrant
on June 5, 1997.)
10(l) Asset Purchase Agreement, dated as of November 3,
1997, by and between Hanger Prosthetics &
Orthotics, Inc., Morgan Prosthetic-Orthotics, Inc.
and Dan Morgan. (Incorporated herein by reference
to Exhibit 10(v) to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1997.)
10(m) Asset Purchase Agreement, dated as of December 23,
1997, by and between Hanger Prosthetics &
Orthotics, Inc., Harshberger Prosthetic & Orthotic
37
Center, Inc., Harshberger Prosthetic & Orthotic
Center of Mobile, Inc., Harshberger Prosthetic &
Orthotic Center of Florence, Inc., FAB-CAM, Inc.
and Jerald J. Harshberger. (Incorporated herein by
reference to Exhibit 10(w) to the Registrant's
Annual Report on Form 10-K for the year ended
December 31, 1997.)
10(n) Stock Purchase Agreement, dated as of April 2, 1999,
by and among NovaCare, Inc., NC Resources, Inc.,
the Registrant and HPO Acquisition Corporation,
Amendment No. 1 thereto, dated as of May 19, 1999,
and Amendment No. 2 thereto, dated as of June 30,
1999. (Incorporated herein by reference to Exhibit
2(a) to the Registrant's Current Report on Form 8-K
dated July 15, 1999.)
10(o) Indenture, dated as of June 16, 1999, among the
Registrant, its subsidiaries and U.S. Bank Trust
National Association, as Trustee. (Incorporated
herein by reference to Exhibit 10(a) to the
Registrant's Current Report on Form 8-K dated July
1, 1999.)
10(p) Form of First Supplemental Indenture, dated as of
August 12, 1999, to Indenture, dated as of June 16,
1999, among the Registrant, its subsidiaries and
U.S. Bank Trust National Association, as Trustee.
(Filed with original Registration Statement on Form
S-4 on August 12, 1999.)
10(q) Credit Agreement, dated as of June 16, 1999, among
the Registrant, various bank lenders, and The Chase
Manhattan Bank, as administrative agent, collateral
agent and issuing bank, Chase Securities Inc., as
lead arranger and book manager, Bankers Trust
Company, as syndication agent, and Paribas, as
documentation agent. (Incorporated herein by
reference to Exhibit 10(a) to the Registrant's
Current Report on Form 8-K dated July 1, 1999.)
10(r) Senior Subordinated Note Purchase Agreement, dated as
of June 9, 1999, relating to 11.25% Senior
Subordinated Notes due 2009, among the Registrant,
Deutsche Banc Securities Inc., Chase Securities
Inc. and Paribas Corporation. (Incorporated herein
by reference to Exhibit 10(b) to the Registrant's
Current Report on Form 8-K dated July 1, 1999.)
10(s) Registration Rights Agreement, dated as of June 16,
1999, by and among the Registrant, Deutsche Banc
Securities, Inc., Chase Securities Inc. and Paribas
Corporation, relating to the 11.25% Senior
Subordinated Notes due 2009. (Incorporated herein
by reference to Exhibit 10(d) to the Registrant's
Current Report on Form 8-K dated July 1, 1999.)
--------------------------
* Management contract or compensatory plan
38
10(t) Securities Purchase Agreement, dated as of June 16,
1999, Relating to 7% Redeemable Preferred Stock,
among the Registrant, Chase Equity Associates, L.P.
and Paribas North America, Inc. (Incorporated
herein by reference to Exhibit 10(e) to the
Registrant's Current Report on Form 8-K dated July
1, 1999.)
10(u) Investor Rights Agreement, dated July 1, 1999, among
the Registrant, Chase Equity Associates, L.P. and
Paribas North America, Inc. (Incorporated herein by
reference to Exhibit 10(f) to the Registrant's
Current Report on Form 8-K dated July 1, 1999.)
10(v) Employment Agreement, dated as of April 29, 1999,
between the Registrant and Ivan R. Sabel.
(Incorporated herein by reference to Exhibit 10(r)
to the Registrant's Registration Statement on Form
S-4 (File No. 333-85045).)*
10(w) Employment Agreement, dated as of April 29, 1999,
between the Registrant and Richard A. Stein.
(Incorporated herein by reference to Exhibit 10(s)
to the Registrant's Registration Statement on Form
S-4 (File No. 333-85045).)*
10(x) Employment Agreement, dated as of July 1, 1999,
between the Registrant and Rick Taylor.
(Incorporated herein by reference to Exhibit 10(u)
to the Registrant's Registration Statement on Form
S-4 (File No. 333-85045).)*
10(y) Employment Agreement, dated as of August 1, 1998,
between DOBI-Symplex, Inc., a subsidiary of the
Registrant, and James G. Cairns, Jr. (Incorporated
herein by reference to Exhibit 10(v) to the
Registrant's Registration Statement on Form S-4
(File No. 333-85045).)*
10(z) Employment Agreement, dated as of November 1, 1996,
between the Registrant and Ron May. (Incorporated
herein by reference to Exhibit 10(w) to the
Registrant's Registration Statement on Form S-4
(File No. 333-85045).)*
21 List of Subsidiaries of the Registrant.
23 Consent of PricewaterhouseCoopers LLP
------------------------
* Management contract or compensatory plan
39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: March 30, 2001 By: /s/IVAN R. SABEL, CPO
---------------------------------
Ivan R. Sabel, CPO
Chairman, President and
Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons, on behalf of the
Registrant and in the capacities and on the dates indicated.
Dated: March 30, 2001 /s/IVAN R. SABEL, CPO
---------------------------------
Ivan R. Sabel, CPO
Chairman, President and
Chief Executive Officer
(Principal Executive Officer)
Dated: March 30, 2001 /s/DENNIS T. CURRIER
---------------------------------
Dennis T. Currier
Chief Financial Officer
(Principal Financial Officer)
Dated: March 30, 2001 /s/DENEANE M. BUTLER
---------------------------------
Deneane M. Butler
Controller, Secretary and
Treasurer
(Principal Accounting Officer)
40
Dated: March 28, 2001 /s/MITCHELL J. BLUTT, M.D.
---------------------------------
Mitchell J. Blutt, M.D.
Director
Dated: March 28, 2001 /s/EDMOND E. CHARRETTE, M.D.
---------------------------------
Edmond E. Charrette, M.D.
Director
Dated: March 28, 2001 /s/THOMAS P. COOPER, M.D.
---------------------------------
Thomas P. Cooper, M.D.
Director
Dated: March 28, 2001 /s/ROBERT J. GLASER, M.D.
---------------------------------
Robert J. Glaser, M.D.
Director
---------------------------------
C. Raymond Larkin, Jr.
Director
---------------------------------
Risa J. Lavizzo-Mourey, M.D.
Dated: March 28, 2001 /s/WILLIAM L. MCCULLOCH
---------------------------------
William L. McCulloch
Director
Dated: March 28, 2001 /s/H.E. THRANHARDT, CPO
---------------------------------
H.E. Thranhardt, CPO
Director
41
INDEX TO FINANCIAL STATEMENTS
Hanger Orthopedic Group, Inc.
----------------------------
Report of Independent Accountants F-1
Consolidated balance sheets as of December 31, 1999
and 2000 F-2
Consolidated statements of operations for the years
ended December 31, 1998, 1999 and 2000 F-4
Consolidated statements of changes in shareholders'
equity for the years ended December 31, 1998,
1999 and 2000 F-5
Consolidated statements of cash flows for the years
ended December 31, 1998, 1999 and 2000 F-6
Notes to Consolidated Financial Statements F-7
Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts S-1
42
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Hanger Orthopedic Group, Inc.:
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) on page 34 present fairly, in all material
respects, the financial position of Hanger Orthopedic Group, Inc. and its
subsidiaries at December 31, 1999 and 2000, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 2000, in conformity with accounting principles generally
accepted in the United States of America. In addition, in our opinion, the
financial statement schedule listed in the index appearing under Item 14(a)(2)
on page 34 presents fairly, in all material respects, the information set
forth therein when read in conjunction with the related consolidated financial
statements. These financial statements and financial statement schedule are
the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
March 28, 2001
F-1
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share amounts)
December 31,
----------------------------------
1999 2000
------ ------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $5,735 $20,669
Accounts receivable, less allowances for doubtful accounts
of $17,866 and $23,005 in 1999 and
2000, respectively 103,125 111,210
Inventories 59,915 61,223
Prepaid expenses and other assets 5,222 4,262
Income tax 3,644 6,325
Deferred income taxes 11,778 20,038
--------- ---------
--------- ---------
Total current assets 189,419 223,727
--------- ---------
--------- ---------
PROPERTY, PLANT AND EQUIPMENT
Land 4,177 4,177
Buildings 8,886 8,876
Machinery and equipment 26,677 31,393
Furniture and fixtures 8,629 9,968
Leasehold improvements 13,004 16,925
--------- ---------
--------- ---------
61,373 71,339
Less accumulated depreciation and amortization 15,269 24,345
--------- ---------
--------- ---------
46,104 46,994
--------- ---------
--------- ---------
INTANGIBLE ASSETS
Excess cost over net assets acquired 498,612 490,724
Non-compete agreements 2,019 1,426
Patents 9,768 9,924
Assembled work force 7,000 7,000
Other intangible assets 15,833 17,082
--------- ---------
--------- ---------
533,232 526,156
Less accumulated amortization 20,412 36,533
--------- ---------
--------- ---------
512,820 489,623
--------- ---------
--------- ---------
OTHER ASSETS 1,738 1,474
--------- ---------
--------- ---------
TOTAL ASSETS $750,081 $761,818
========= =========
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
F-2
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share amounts)
December 31,
-----------------------------------
-----------------------------------
1999 2000
----------------- ----------------
----------------- ----------------
LIABILITIES, REDEEMABLE PREFERRED STOCK
SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt $25,406 $37,595
Accounts payable 16,714 17,809
Accrued expenses 5,445 9,380
Accrued interest payable 4,768 7,559
Accrued compensation related cost 18,658 17,385
Deferred revenue - 309
-------- ---------
-------- ---------
Total current liabilities 70,991 90,037
-------- ---------
-------- ---------
Long-term debt 426,211 422,838
Deferred income taxes 13,481 26,026
Other liabilities 5,141 2,656
-------- ---------
-------- ---------
Total Liabilities 515,824 541,557
-------- ---------
-------- ---------
7% Redeemable Convertible Preferred stock, liquidation preference $1,000 per share 61,343 65,881
-------- ---------
-------- ---------
Commitments and contingent liabilities (See Note K)
SHAREHOLDERS' EQUITY
Common stock, $.01 par value; 60,000,000 shares authorized, 19,043,497 shares
and 18,910,002 shares issued and outstanding in 1999 and 2000 190 190
Additional paid-in capital 146,498 146,498
Retained earnings 26,882 8,348
-------- ---------
-------- ---------
173,570 155,036
Treasury stock, cost -- (133,495 shares) (656) (656)
-------- ---------
-------- ---------
172,914 154,380
-------- ---------
-------- ---------
TOTAL LIABILITIES, REDEEMABLE PREFERRED STOCK
-------- ---------
-------- ---------
AND SHAREHOLDERS' EQUITY $750,081 $761,818
========= =========
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31,
(Dollars in thousands, except share and per share amounts)
1998 1999 2000
--------------- --------------- ----------------
--------------- --------------- ----------------
Net sales $187,870 $346,826 $486,031
Cost of products and services sold 92,903 169,076 251,368
--------- --------- ---------
--------- --------- ---------
Gross profit 94,967 177,750 234,663
Selling, general and administrative 63,512 113,643 177,519
Depreciation and amortization 3,294 6,538 11,178
Amortization of excess cost over net assets acquired 2,488 7,520 12,150
Restructuring costs --- 1,305 654
Integration costs --- 5,035 1,710
--------- --------- ---------
--------- --------- ---------
Income from operations 25,673 43,709 31,452
Interest expense, net (1,902) (22,177) (47,072)
Other expense, net (315) (352) 127
--------- --------- ---------
--------- --------- ---------
Income (loss) before taxes 23,456 21,180 (15,493)
Provision (benefit) for income taxes 9,616 10,194 (1,497)
--------- --------- ---------
--------- --------- ---------
Net income (loss) $13,840 $10,986 ($13,996)
========= ========= =========
========= ========= =========
Net income (loss) applicable to common stock $13,818 $8,831 ($18,534)
========= ========= =========
========= ========= =========
Basic Per Common Share Data
- --------------------------------------
Net income (loss) $0.82 $0.47 ($0.98)
========= ========= =========
========= ========= =========
Shares used to compute basic per common share amounts 16,812,717 18,854,751 18,910,002
========= ========= =========
========= ========= =========
Diluted Per Common Share Data
- --------------------------------------
Net income (loss) * $0.75 $0.44 ($0.98)
========= ========= =========
========= ========= =========
Shares used to compute diluted per common share amounts * 18,515,567 20,005,282 18,910,002
========= ========= =========
========= ========= =========
* For 1999 and 2000, excludes the effect of the conversion 7% Redeemable
Convertible Preferred Stock into Common Stock as it is considered
anti-dilutive.
The accompanying notes are an integral part of the
consolidated financial statements.
F-4
HANGER ORTHOPEDIC GROUP, INC
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 1998, 1999 and 2000
(In thousands)
Retained
Additional Earnings
Common Common Paid in (Accumulated Treasury
Shares Stock Capital Deficit) Stock Total
---------- ---------- ------------ ------------ ----------- -----------
Balance, December 31, 1997 15,537 $157 $102,586 $4,233 ($656) $106,320
--------- ---------- ------------ ------------ ----------- ------------
Preferred dividends declared (22) (22)
Net Income 13,840 13,840
Issuance of Common Stock in
connection with the exercise
of stock options 338 3 2,252 2,255
Issuance of Common Stock in
connection with the exercise
of stock warrants 276 3 (3)
Issuance of Common Stock in
connection with acquisitions 141 1 2,399 2,400
Issuance of Common Stock in
Public Offering 2,400 24 37,736 37,760
--------- ---------- ------------ ------------ ----------- ------------
Balance, December 31, 1998 18,692 188 144,970 18,051 (656) 162,553
--------- ---------- ------------ ------------ ----------- ------------
Preferred dividends declared (2,118) (2,118)
Accretion of Preferred Stock (37) (37)
Net Income 10,986 10,986
Issuance of Common Stock in
connection with the exercise
of stock options 184 2 861 863
Issuance of Common Stock in
connection with acquisitions 23 500 500
Conversion of Seller Notes
into Shares of Common Stock 11 167 167
--------- ---------- ------------ ------------ ----------- ------------
Balance, December 31, 1999 18,910 190 146,498 26,882 (656) 172,914
--------- ---------- ------------ ------------ ----------- ------------
Preferred dividends declared (4,464) (4,464)
Accretion of Preferred Stock (74) (74)
Net Loss (13,996) (13,996)
--------- ---------- ------------ ------------ ----------- ------------
Balance, December 31, 2000 18,910 $190 $146,498 $8,348 ($656) $154,380
--------- ---------- ------------ ------------ ----------- ------------
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31,
(Dollars in thousands)
1998 1999 2000
------------ ------------ -------------
------------ ------------ -------------
Cash flows from operating activities:
Net income (loss) $13,840 $10,986 ($13,996)
Adjustments to reconcile net income (loss) to net cash provided
by (used in)
operating activities:
Loss on disposal of assets --- 37 ---
Provision for bad debt 7,510 15,046 23,620
Provision for inventory reserves 2,202 --- 120
Depreciation and amortization 3,294 6,538 11,178
Amortization of excess cost over net assets acquired 2,488 7,520 12,150
Amortization of debt discount and debt issue costs --- 1,059 2,436
Deferred taxes (benefit) (554) 662 (3,200)
Restructuring costs --- 1,305 654
Changes in assets and liabilities, net of effects from
acquired companies:
Accounts receivable (10,773) (19,367) (31,089)
Inventories 256 (10,372) (1,113)
Prepaid and other assets 611 (2,493) 259
Other assets (87) 1,156 273
Accounts payable (586) 2,896 982
Accrued expenses (67) (4,638) 4,794
Accrued wages & payroll taxes 247 (6,127) (1,287)
Deferred revenue --- --- 309
Other liabilities 150 (4,432) (2,483)
------------ ------------ -------------
------------ ------------ -------------
Net cash provided by (used in) operating activities 18,531 (224) 3,607
------------ ------------ -------------
------------ ------------ -------------
Cash flows from investing activities:
Purchase of fixed assets (2,859) (12,598) (9,845)
Acquisitions, net of cash acquired (30,333) (432,291) (9,958)
Cash received pursuant to purchase price adjustment --- --- 24,700
Proceeds from sale of certain assets, net of cash --- 397 ---
Purchase of non-compete agreements (398) (294) (87)
Purchase of customer list --- --- (30)
Other (60) (209) (156)
------------ ------------ -------------
------------ ------------ -------------
Net cash provided by (used in) investing activities (33,650) (444,995) 4,624
------------ ------------ -------------
------------ ------------ -------------
Cash flows from financing activities:
Net borrowings under revolving credit agreement --- 55,000 29,700
Repayment of term loans --- --- (8,250)
Proceeds from issuance of preferred stock, net --- 59,188 ---
Redemption of preferred stock (326) --- ---
Proceeds from issuance of Common Stock 40,016 863 ---
Proceeds from long-term debt 6,000 350,000 ---
Repayment of long-term debt (27,445) (9,089) (13,521)
Increase in financing costs --- (14,691) (1,226)
------------ ------------ -------------
------------ ------------ -------------
Net cash provided by financing activities 18,245 441,271 6,703
------------ ------------ -------------
------------ ------------ -------------
Increase (decrease) in cash and cash equivalents 3,126 (3,948) 14,934
Cash and cash equivalents at beginning of year 6,557 9,683 5,735
------------ ------------ -------------
------------ ------------ -------------
Cash and cash equivalents at end of year $9,683 $5,735 $20,669
============ ============ =============
============ ============ =============
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
HANGER ORTHOPEDIC GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share and per share amounts)
NOTE A - THE COMPANY
Hanger Orthopedic Group, Inc. is the nation's largest professional
practice management company in the orthotics & prosthetics ("O&P")
rehabilitation industry. In addition to providing O&P patient-care services
through its operating subsidiaries, the Company also manufactures and
distributes components and finished patient-care products to the O&P industry
primarily in the United States. Hanger's subsidiary, Hanger Prosthetics &
Orthotics, Inc. formerly known as J.E. Hanger, Inc., was founded in 1861 by a
Civil War amputee and is the oldest company in the O&P industry in the United
States. Orthotics is the design, fabrication, fitting and supervised use of
custom-made braces and other devices that provide external support to treat
musculoskeletal disorders. Prosthetics is the design, fabrication and fitting
of custom-made artificial limbs.
The Company has obtained financing from various sources to provide the
necessary funding for acquisitions and working capital requirements. As
discussed in Note H, the Company was not in compliance with the financial
covenants of its Credit Agreement as of December 31, 1999 and 2000. The
Company's Credit Agreement was amended on March 29, 2000 and March 16, 2001 to
provide waivers of non-compliance as well as to ease the restriction of
certain financial covenants with respect to 2001 and 2002.
NOTE B - SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries. All
intercompany transactions and balances have been eliminated.
Use of Estimates: The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents: The Company considers all highly liquid
investments with original maturities of three months or less at the date of
purchase to be cash equivalents. At various times throughout the year, the
Company maintains cash balances in excess of FDIC limits.
Fair Value of Financial Instruments: The carrying value of the Company's
short-term financial instruments, such as receivables and payables,
F-7
approximate their fair values, based on the short-term maturities of these
instruments. The carrying value of the Company's long-term debt approximates
fair value based on using rates currently available to the Company for debt
with similar terms and remaining maturities.
Inventories: Inventories, which consist principally of purchased parts,
are stated at the lower of cost or market using the first-in, first-out (FIFO)
method. The Company calculates cost of goods sold in accordance with the gross
profit method. The Company bases the estimates used in applying the gross
profit method on the actual results of the most recently completed fiscal year
and other factors affecting cost of goods sold during the current reporting
periods. Estimated cost of goods sold during the period is adjusted when the
annual physical inventory is taken. In the fourth quarter of 2000, the Company
recorded a book-to-physical adjustment of approximately $9.6 million. The
Company treated this adjustment as a change in accounting estimate in
accordance with the provisions of Accounting Principles Board Opinion No. 20.
Long-Lived Asset Impairment: The Company reviews its long-lived assets
for impairment whenever events or changes in circumstances indicate that the
carrying amount of the assets may not be recoverable through future cash flows
such as: a significant decrease in the market value of the Company's assets;
or a significant adverse change in legal factors or in the business climate
that could affect the value of an asset or an adverse action or assessment by
a regulator; or a significant adverse change in third-party reimbursement
requirements. If it is determined that an impairment loss has occurred based
on expected cash flows undiscounted, before interest and taxes, then the
extent of the impairment is calculated, based on net cash flows and the loss
is recognized in the statement of operations. Management's review of future
cash flows associated with long-lived assets has not indicated an impairment
of those assets during the periods presented.
Property, Plant and Equipment: Property, plant and equipment are recorded
at cost. The cost and related accumulated depreciation of assets sold, retired
or otherwise disposed of are removed from the respective accounts, and any
resulting gains or losses are included in the statement of operations.
Depreciation is computed for financial reporting purposes using the
straight-line method over the estimated useful lives of the related assets as
follows: machinery and equipment and furniture and fixtures - 5 years;
leasehold improvements - shorter of the asset life or term of lease; and
buildings - 10-20 years. Depreciation expense was approximately $2,806 and
$5,251 and $9,009 for the years ended December 31, 1998, 1999 and 2000,
respectively.
Intangible Assets: Non-compete agreements 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. Other
intangible assets are recorded at cost and are amortized over their estimated
useful lives of up to 16 years using the straight-line method. Excess cost
over net assets acquired represents the excess of purchase price over the
value assigned to net identifiable assets of purchased businesses and is
amortized using the straight-line method over 40 years.
Revenue Recognition: Revenue on the sale of orthotic and prosthetic
devices is recorded when the device is accepted by the patient. Revenues from
referral service contracts is recognized over the term of the contract.
Deferred revenue represents billings made prior to the final fitting and
F-8
acceptance by the patient and unearned service contract revenue. Revenue is
recorded at its net realizable value taking into consideration all
governmental and contractual discounts.
Credit Risk: The Company primarily provides services and customized
devices throughout the United States and is reimbursed by the patients'
third-party insurers or governmentally funded health insurance programs. The
Company performs ongoing credit evaluations of its distribution customers.
Accounts receivable are not collateralized. The ability of the Company's
debtors to meet their obligations is dependent upon the financial stability of
the insurers of the Company's customers and future legislation and regulatory
actions. Additionally, the Company maintains reserves for potential losses
from these receivables that historically have been within management's
expectations.
Income Taxes: Income taxes are determined in accordance with Statement of
Financial Accounting Standards ("SFAS") 109, which requires recognition of
deferred income tax liabilities and assets for the expected future tax
consequences of events that have been included in the financial statements or
tax returns. Under this method, deferred income tax liabilities and assets are
determined based on the difference between financial statement and tax bases
of assets and liabilities using enacted tax rates in effect for the year in
which the differences are expected to reverse. SFAS 109 also provides for the
recognition of deferred tax assets if it is more likely than not that the
assets will be realized in future years.
Stock-Based Compensation: Compensation costs attributable to stock option
and similar plans are recognized based on any difference between the quoted
market price of the stock on the date of the grant over the amount the
employee is required to pay to acquire the stock (the intrinsic value method
under Accounting Principles Board Opinion 25). SFAS 123, "Accounting for
Stock-Based Compensation," requires companies electing to continue to use the
intrinsic value method to make pro forma disclosures of net income and
earnings per share as if the fair value based method of accounting had been
applied. The Company has adopted the disclosure only provisions of SFAS 123.
Comprehensive Income: Effective January 1, 1998 the Company adopted the
provisions of SFAS 130, "Reporting Comprehensive Income." SFAS 130 establishes
standards for reporting and display of comprehensive income and its components
in the financial statements. The adoption of SFAS 130 had no effect on the
Company's consolidated financial statements.
Segment Information: SFAS 131, "Disclosures about Segments of an
Enterprise and Related Information" applies a "management" approach to
disclosure of segment information. The management approach designates the
internal organization that is used by management for making operating
decisions and assessing performance as the source of the Company's reportable
segments. SFAS 131 also requires disclosure about products and services,
geographic areas and major customers.
New Accounting Standards: In June 1998, the Financial Accounting Standard
Board issued SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities," which is effective for fiscal years beginning after June 15,
2000. SFAS 133 requires that an entity recognize all derivative instruments as
either assets or liabilities on its balance sheet at their fair value. Changes
in the fair value of derivatives are recorded each period in current earnings
or other comprehensive income, depending on whether a derivative is designated
F-9
as part of a hedge transaction, and, if it is, the type of hedge transaction.
The Company has adopted SFAS 133 as of January 1, 2001. As the Company does
not use derivative instruments, SFAS 133 did not have a material effect on the
financial position or results of operations of the Company at January 1, 2001.
In December 1999, the of the Securities and Exchange Commission released
Staff Accounting Bulletin No. 101 ("SAB 101"). "Revenue Recognition," to
provide guidance on the recognition, presentation and disclosure of revenue in
financial statements. The Company believes that its revenue recognition
practices are in conformity with the guidelines in SAB 101, as revised, and
that this pronouncement will have no material impact on its financial
statements.
In March 2000, the FASB released Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation: an interpretation of APB
Opinion No. 25." Interpretation No. 44 provided clarification of certain
issues, such as determination of who is an employee, the criteria for
determining whether a plan qualifies as a non-compensatory plan, the
accounting consequence of various modifications to the terms of a previously
fixed stock option or award and the accounting for an exchange of stock
compensation awards in a business combination. The Company believes that its
practices are in conformity with this guidance, and therefore No. 44 has no
impact on its financial statements.
In 2000, the FASB issues SFAS No. 137, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" (which was
amended by SFAS 140). This statement replaces SFAS No. 125 (of the same name).
SFAS No. 140 carries over the main provisions of SFAS No. 125 concerning and
servicing of Financial Assets. At December 31, 2000, this standard would not
have impacted the Company's financial statements.
F-10
NOTE C - SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION
The following are the supplemental disclosure requirements for the
statements of cash flows:
For the Years Ended December 31,
--------------------------------
1998 1999 2000
---- ---- ----
Cash paid during the period for:
Interest $2,099 $18,261 $42,645
Income taxes 8,307 12,400 2,666
Non-cash financing and investing activities:
Preferred stock dividends declared and accretion 22 2,155 4,538
Issuance of notes in connection with acquisitions 7,934 3,006 2,874
Issuance of Common Stock in connection with acquisitions 2,400 500 ---
Conversion of seller notes into shares of Common Stock --- 167 ---
NOTE D - ACQUISITIONS
During 1998, the Company acquired seventeen orthotic and prosthetic
companies and one prosthetic component manufacturing company. The aggregate
purchase price, excluding potential earn-out provisions, was $39,125,
comprised of $28,791 in cash, $7,934 in promissory notes and 141,417 shares of
common stock of the Company valued at $2,400. The notes are payable over one
to five years with interest rates ranging from 6.0000% to 7.6875%. The cash
portion of the purchase price for these acquisitions was borrowed under the
Company's revolving and acquisition loan commitment.
During 1998, the Company paid approximately $591 to the former owners of
ACOR Orthopaedic, Inc. - Retail Division and Montana Orthotics and
Prosthetics, Inc., pursuant to earnout provisions contained in the 1997
acquisition agreements. In addition, the Company paid approximately $1,528 to
the former owners of Seattle Limb Systems, Inc., Fort Walton Orthopedic Inc.
and Mobile Limb and Brace, Inc., Morgan Prosthetics - Orthotics, Inc. and
Eugene Teufel & Sons, Inc., pursuant to working capital provisions contained
in the respective acquisition agreements. The Company has accounted for these
additional payments as additional purchase price resulting in an increase to
excess of cost over net assets acquired in the amount of $2,119.
Following the acquisition of NovaCare O&P in 1999, the Company and
NovaCare disagreed regarding the determination of the amount of NovaCare O&P
adjusted working capital and on February 25, 2000, the Company and NovaCare
submitted the matter to the independent arbitrator in accordance with the
dispute resolution arbitration mechanism provided under the Stock Purchase
Agreement. The agreement provided that such arbitrator's determination would
be conclusive and binding upon the parties. On May 22, 2000, an independent
arbitrator issued its report concluding that the Company was entitled to the
working capital deficiency of approximately $25.1 million, representing the
required decrease in the purchase price previously paid by the Company for
NovaCare O&P. On May 25, 2000, the escrow agent released the $15.0 million of
F-11
escrowed funds to the Company. Pursuant to the Stock Purchase Agreement, the
Company was entitled to receive the approximately $10.1 million balance of the
working capital deficiency on or before June 21, 2000, which was 30 days after
the date of the independent arbitrator determination.
On June 5, 2000, NovaCare (the name of which was changed to NAHC, Inc.)
filed a Complaint in the Court of Chancery of the State of Delaware in and for
New Castle County against the Company, our subsidiary, HPO Acquisition Corp.,
and the escrow agent alleging the wrongful release of the escrowed funds and
seeking the return of such escrowed funds to the Escrow Agent. On June 9,
2000, we filed an answer and counterclaim requesting the Court to dismiss the
Complaint and confirm the entire independent arbitrator award.
On June 30, 2000, the Company entered into a Settlement Agreement with
NovaCare providing for dismissal of the litigation and execution of a mutual
release relating to currently unknown matters arising from the acquisition. In
addition, the Settlement Agreement provided that of the $10.1 million owed by
NovaCare to the Company, $6.0 million would be paid immediately by NovaCare
and NovaCare would execute a collateralized promissory note in the principal
amount of $3.7 million, plus 7% annual interest, payable monthly over the
following six months. Actual payment of the $6.0 million was received by the
Company on July 3, 2000. The Company determined it would be prudent to enter
into an agreement, under which the Company gave NovaCare a $0.4 million
discount in exchange for the immediate payment of $6.0 million and the greater
certainty of receiving $3.7 million under the promissory note. The $3.7
million was received in a timely manner with some minor deductions relating to
certain other outstanding accounts payable between the parties.
Included in liabilities assumed are restructure provisions which are more
fully described in Note E. Additionally, certain contingent liabilities, more
fully described in Note K, exist which, when resolved may result in adjustment
of the purchase price cost allocation.
During 1999, the Company acquired five other orthotic and prosthetic
companies. The aggregate purchase price, excluding potential earn-out
provisions, was $12.1 million, comprised of $8.6 million, in cash, $2.9
million in promissory notes and 23,000 shares of Common Stock of the Company
valued at $500.
Hanger required approximately $430.2 million in cash to close the
acquisition of NovaCare O&P, to pay approximately $20.0 million of related
fees and expenses, including debt issue costs of approximately $16.0 million,
and to refinance existing debt of approximately $2.5 million. The funds were
raised by Hanger through (i) borrowing approximately $230.0 million of
revolving credit and term loans under a new bank facility; (ii) selling $150.0
million principal amount of 11.25% Senior Subordinated Notes due 2009; and
(iii) selling $60.0 million of 7% Redeemable Preferred Stock. The new bank
credit facility consists of a $100.0 million revolving credit facility, of
which $30.0 million was drawn on in connection with the acquisition of
NovaCare O&P, a Tranche A term facility and a Tranche B term facility.
The acquisition of NovaCare O&P has been accounted for as a business
combination in accordance with the purchase method. The results of operations
F-12
for this acquisition have been included in the Company's results since July 1,
1999. Excess cost over net assets acquired includes goodwill and other
intangible assets. Goodwill is amortized using the straight-line method over
40 years. Other intangible assets of $15.0 million, primarily patents, are
amortized over periods of between 8 and 11 years.
Additionally, the Company paid during 1999, approximately $9.9 million
and issued $126.0 in notes related to seven orthotic and prosthetic companies
acquired in years prior to 1999. The payments were primarily made pursuant to
earnout and working capital provisions contained in the respective acquisition
agreements. The Company has accounted for these amounts as additional purchase
price resulting in an increase to excess of cost over net assets acquired in
the amount of $10.0 million.
During 2000, the Company acquired five orthotic and prosthetic companies.
The aggregate purchase price, excluding potential earn-out provisions, was
$4.5 million, comprised of $2.4 million in cash and $2.1 million in promissory
notes. The notes are payable over two to five years with interest rates
ranging from 6% to 8%. The cash portion of the purchase price for these
acquisitions was borrowed under the Company's revolving credit facility.
All of the above acquisitions have been accounted for as business
combinations in accordance with the purchase method. The results of operations
for these acquisitions are included in the Company's results of operations
from their date of acquisition. Excess cost over net assets acquired in these
acquisitions amounting to approximately $32.9 million, $374.6 million and $3.6
million in 1998, 1999 and 2000, respectively, are amortized using the
straight-line method over 40 years.
The following table summarizes the unaudited consolidated pro forma
information, assuming the NovaCare O&P acquisition had occurred at the
beginning of each of the following periods:
1998 1999
---- ----
Net sales $ 492,417 $ 482,502
Net income (loss) 2,497 (1,609)
Diluted loss per common share (1) ($.10) ($.31)
(1) Excludes potentially dilutive Common Stock and includes an adjustment
to net loss for Preferred Stock Dividends.
The unaudited consolidated pro forma results do not necessarily represent
results which would have occurred if the acquisitions had taken place at the
beginning of each period, nor are they indicative of the results of future
combined operations or trends.
Adjustments made in arriving at the unaudited consolidated pro forma
results include increased interest expense on acquisition debt, amortization
of goodwill, adjustments to the fair value of assets acquired and depreciable
lives, preferred stock dividends, and related tax adjustments.
F-13
Additionally during 2000, the Company paid, approximately $7.6 million
and issued $750.0 in notes related to 15 orthotic and prosthetic companies
acquired in years prior to 2000. The payments were primarily made pursuant to
earnout and working capital provisions contained in the respective acquisition
agreements. The Company has accounted for these amounts as additional purchase
price resulting in an increase to excess of cost over net assets acquired in
the amount of $8.4 million. Additional amounts aggregating approximately $13.9
million may be paid in connection with earnout provisions contained in
acquisition agreements.
NOTE E -INTEGRATION & RESTRUCTURING COSTS
The Company has made an assessment of the restructuring costs to be
incurred relative to the acquisition of NovaCare O&P. Affected by the plan of
restructuring are approximately 54 patient care centers to be closed,
including approximately 29 Hanger and 25 NovaCare O&P locations. The Company
began formulating, and commenced, a plan of restructuring on July 1, 1999,
which is now complete. Since commencement of the plan of restructuring, the
Company has transitioned patients being cared for at closed patient care
centers to other patient care centers generally within proximity to a closed
branch. During 1999, the Company recorded approximately $5.6 million in
restructuring liabilities for the costs associated with the restructuring of
the NovaCare O&P operations and allocated such costs to the purchase price of
NovaCare O&P in accordance with purchase accounting requirements. The Company
also accrued approximately $1.3 million ($796.0 after tax) for the costs
associated with the restructuring of the existing Hanger operations in
conjunction with the NovaCare O&P acquisition and the Company has recorded
such charges in the statement of operations.
The above-referenced restructuring costs primarily include severance pay
benefits and lease termination costs. The cost of providing severance pay and
benefits for the reduction of approximately 225 employees is estimated at
approximately $3.4 million and is primarily a cash expense. Total employee
terminations included approximately 70 acquired corporate and 155 patient-care
center employees. Employees terminated at patient-care centers include most,
if not all, employees at each patient care center closed. During 1999,
approximately 195 employees were terminated including approximately 53
acquired corporate employees and 142 patient care center employees. Lease
termination costs, for patient care centers closed, are estimated at $3.5
million, are cash expenses and are expected to be paid through 2003. During
1999, 54 patient care centers were identified for closure. As of December 31,
2000, all of the reduction in force had been completed. Management decided to
amend the original restructuring plan which called for the closure of 54
patient care centers. As of December 31, 2000, 44 of the patient care centers
were closed and management reversed approximately $672.0 of the restructuring
reserve providing an approximate restructuring benefit during the fourth
quarter 2000 of $381.0 and a reduction of goodwill of approximately $291.0.
Additionally, in relation to the acquisition of NovaCare O&P, the Company
recorded integration costs of approximately $5.0 million, including costs of
changing patient care center names, payroll and related benefits, conversion,
stay-bonuses and related benefits for transitional employees and certain other
costs related to the acquisition. These costs were expensed as incurred and
F-14
recorded against operations during 1999.
In December of 2000, management and the Board of Directors determined
that major performance improvement initiatives needed to be adopted. Two
hundred and thirty-four (234) employees were severed and the Company retained
Jay Alix & Associates ("JA&A") to do an assessment of the opportunities
available for improved financial and operating performance. JA&A was retained
to develop a comprehensive performance improvement program.
During the fourth quarter of 2000, management implemented a plan to sever
two-hundred thirty-four (234) employees in an effort to reduce general and
administrative expenses. The Company recorded approximately $1.0 million in
restructuring expense (this amount is offset by approximately $381.0
restructuring benefit described above). As of December 31, 2000, the Company
recorded approximately $0.7 million in restructuring liabilities. Those
amounts were paid in January of 2001, thus completing the plan of
restructuring. Additionally, the Company recorded approximately $1.7 million
in integration expenses during the period.
Components of the restructuring reserves for 1999 and 2000, spending
during the periods, and remaining reserve balances are as follows:
Lease Termination
Employee and other Exit Total
Severance Costs Costs Restructuring
Reserve
------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 $ ----- $ ----- $ -----
Provision for existing Hanger Business 223 1,082 1,305
Provision for existing NovaCare O&P Business 3,145 2,570 5,715
Spending (1,768) (660) (2,428)
--------------------------------------------------
Balance at December 31, 1999 1,600 2,992 4,592
Provision 1,035 ----- 1,035
Spending (1,942) (913) (2,855)
Amendment to Plan ------ (672) (672)
--------------------------------------------------
Balance at December 31, 2000 $ 693 $ 1,407 $ 2,100
==================================================
NOTE F - NET INCOME PER COMMON SHARE
Basic per common share amounts are computed using the weighted average
number of common shares outstanding during the year. Diluted per common share
amounts are computed using the weighted average number of common shares
outstanding during the year and dilutive potential common shares. Dilutive
potential common shares consist of stock options, stock warrants and
convertible notes payable and are calculated using the treasury stock method.
F-15
Earnings per share are computed as follows:
Years Ended December 31,
1998 1999 2000
---- ---- ----
Net income (loss) $ 13,840 $ 10,986 $ (13,996)
Less preferred stock dividends declared and
accretion (22) (2,155) (4,538)
------------ ----------- ------------
Income (loss) available to common
stockholders used to compute basic per
common share amounts $ 13,818 $ 8,831 (18,534)
============ =========== ============
Add back interest expense on convertible note
payable, net of tax $ 44 $ 51 $ ---
------------ ----------- ============
Income (loss) available to common
stockholders plus assumed conversions to
compute diluted per common share amounts $ 13,862 $ 8,882 $ (18,534)
============== ============= ============
Shares of common stock
outstanding used to compute basic per
common share amounts 16,812,717 18,854,751 18,910,002
Effect of convertible note payable 87,501 92,573 ---
Effect of dilutive options 836,126 541,834 ---
Effect of dilutive warrants 779,223 516,124 ---
Shares used to compute dilutive per ------------ ----------- ------------
common share amounts (1) 18,515,567 20,005,282 18,910,002
============ =========== ============
Basic income per common share $ .82 $ .47 $ (.98)
Diluted income per common share $ .75 $ .44 $ (.98)
(1) For 1999 and 2000, excludes the effect of the conversion of the 7%
Redeemable Convertible Preferred Stock into Common Stock as it is
considered anti-dilutive. For 2000, excludes the effect of all
dilutive options and warrants as a result of the Company's net loss
for the year ended December 31, 2000.
Options to purchase 3,345,693 shares of common stock and warrants to
purchase 830,650 shares of common stock were outstanding at December 31, 2000,
and not included in the computation of diluted income per share due to the
Company's net loss for the year ended December 31, 2000.
Options to purchase 234,250 and 665,333 shares of common stock were
outstanding at December 31, 1998 and 1999, respectively, but were not included
in the computation of diluted income per share for 1998 and 1999 because the
options' prices were greater that the average market price of the common
shares.
F-16
NOTE G - INVENTORY
Inventories at December 31, 1999 and 2000 consist of the following:
1999 2000
---- ----
Raw materials $31,715 $29,482
Work in-process 17,172 19,885
Finished goods 11,028 11,856
-------- --------
$59,915 $61,223
======= =======
NOTE H - LONG-TERM DEBT
Long-term debt consists of the following at December 31, 1999 and 2000:
1999 2000
---- ----
A Term Loan Commitment $100,000 $ 92,500
B Term Loan Commitment 100,000 99,250
Senior subordinated notes 150,000 150,000
Revolving credit facility 55,000 84,700
Subordinated seller notes, non-collateralized net of unamortized
discount of $195.5 and $141.5 at December 31, 1999 and 2000,
respectively, with principal and interest payable in either monthly,
quarterly or annual installments at effective interest rates ranging
from 6% to 11.572%, maturing through January 2009. $ 46,617 $ 33,983
--------- -----------
451,617 460,433
Less current portion 25,406 37,595
--------- -----------
$426,211 $ 422,838
========= ===========
On July 29, 1998, 3,300,000 shares of Common Stock of the Company were
sold in an underwritten public offering at $17.00 per share. Of that amount,
2,400,000 shares were sold by the Company and 900,000 were sold by certain
shockholders of the Company. Of the approximately $37.8 million of net
proceeds of the offering received by the Company, the Company applied $24.7
million to the repayment of the A-Term Loan, B-Term Loan and other
indebtedness.
On June 16, 1999, the Company issued $150.0 million of Senior
Subordinated Notes, bearing interest of 11.25%, and maturing on June 15, 2009.
Interest is payable on June 15 and December 15, commencing on December 15,
1999.
On July 1, 1999, the Company replaced its bank credit facility with a new
facility (the "Credit Agreement") which consists of a $100.0 million Revolving
Credit Facility, a $100.0 million Tranche A Term Facility and $100.0 million
Tranche B Term Facility. The Revolving Credit Facility matures on July 1,
2005; the Tranche A Term Facility is payable in quarterly installments of $5.0
million through July 1, 2005; and the Tranche B Term Facility is payable in
F-17
quarterly installments of $250.0 through December 31, 2004 and in quarterly
installments of $15.8 million through January 1, 2007. The Credit Agreement,
as initially entered into, provided that the Tranche A Term Facility and the
Revolving Credit Facility would carry an annual interest rate of adjusted
LIBOR plus 2.50% or ABR plus 1.50%, and that the Tranche B Term Facility would
carry an annual interest rate of adjusted LIBOR plus 3.50% or ABR plus 2.50%.
At December 31, 1999, the Company was not in compliance with financial
covenants under the Credit Agreement for capital expenditure and adjusted
interest coverage ratio. In consideration for the Banks' waiver of the
Company's non-compliance with these covenants, an amendment to the Credit
Agreement effective March 29, 2000 was entered into which provides for an
increase in the Tranche A Term Facility and the Revolving Credit Facility
annual interest rate to adjusted LIBOR plus 3.00% or ABR plus 2.00%, and an
increase in the Tranche B Term Facility annual interest rate to adjusted LIBOR
plus 4.00% or ABR plus 3.00%. Certain of the financial covenants were eased
with respect to 2000 and 2001 under the terms of the amendment to the Credit
Agreement.
In addition at December 31, 2000, the Company was not in compliance with
the financial covenants under the Credit Agreement for interest coverage and
leverage coverage. In consideration for the bank's waiver of the Company's
non-compliance with these covenants, an amendment to the amended and restated
Credit Agreement dated as of March 16, 2001 was entered into which provides
for an increase in the Tranche A Term Facility and the Revolving Credit
Facility annual interest rate to adjusted LIBOR plus 3.50% or ABR plus 2.50%,
and an increase in the Tranche B Term Facility annual interest rate to
adjusted LIBOR plus 4.50% or ABR plus 3.50%. Certain of the financial
covenants were eased with respect to 2001 and 2002 under the terms of the
amendment to the Credit Agreement.
Matters critical to the Company's compliance with the Credit Facility's
covenants, and ultimately its immediate term liquidity (to the extent
alternative sources of liquidity are not readily available), include improving
operating results, through revenue growth and cost control, and reducing the
Company's investment in working capital. The Company has retained the services
of Jay Alix & Associates to assist in identifying programs aimed at achieving
these objectives. The Company's ability to continue to comply with the Credit
Facility covenants is dependent on certain factors, including (a) the ability
of the Company to effectuate the restructuring initiatives referred to above,
and (b) the Company's ability to continue to attract and retain experienced
management and O&P practitioners. Unexpected increases in the LIBOR rate could
also adversely impact the Company's ability to comply with the Credit
Facility's covenants
The Credit Facility with the Banks is collateralized by substantially all
the assets of the Company, restricts the payment of dividends, and contains
certain affirmative and negative covenants customary in an agreement of this
nature.
F-18
Maturities of long-term debt at December 31, 2000 are as follows:
2001 $37,595
2002 32,477
2003 26,402
2004 107,196
2005 42,571
Thereafter 214,192
---------
$460,433
=========
As of December 31, 2000, the Company had available borrowings under its
Revolving Credit Facility of $15.3 million.
NOTE I- INCOME TAXES
The provisions (benefit) for income taxes for the years ended December
31, 1998, 1999 and 2000 consisted of the following:
1998 1999 2000
---- ---- ----
Current:
Federal $ 8,683 $ 7,844 $ (194)
State 1,486 1,688 1,897
-------- --------- --------
Total 10,169 9,532 1,703
Deferred:
Federal and State (553) 662 (3,200)
-------- -------- ---------
Provision (benefit) for income taxes $ 9,616 $ 10,194 $ (1,497)
======= ======== =========
A reconciliation of the federal statutory tax rate to the effective tax
rate for the years ended December 31, 1998, 1999 and 2000 is as follows:
1998 1999 2000
---- ---- ----
Federal statutory tax rate $ 8,210 $ 7,413 $(5,423)
Increase in taxes resulting from:
State income taxes (net of
federal effect) 985 1,196 1,058
Amortization of the excess cost
over net assets acquired 159 1,733 2,477
Other, net 262 (148) 391
---------- ---------- --------
Provision for income taxes $ 9,616 $ 10,194 $(1,497)
========== ======== =======
Temporary differences and carryforwards which give rise to deferred tax
assets and liabilities as of December 31, 1999 and 2000 are as follows:
1999 2000
---- ----
Deferred Tax Liabilities:
Book basis in excess of tax $ 903 $ 903
F-19
Depreciation and amortization 12,407 24,685
Debt issue costs 732 640
Other --- 300
---------- ----------
14,042 26,528
---------- ----------
Deferred Tax Assets:
Net operating loss 284 1,979
Accrued expenses 5,090 7,370
Reserve for bad debts 5,055 9,098
Inventory capitalization and reserves 1,633 2,093
Acquisition costs 277 ---
---------- ----------
12,339 20,540
---------- ----------
Net deferred tax liabilities ($ 1,703) ($ 5,988)
========== ==========
For Federal tax purposes at December 31, 2000, the Company has available
approximately $5.6 million of net operating loss carryforwards expiring in the
year 2020.
NOTE J - DEFERRED COMPENSATION
In conjunction with the acquisition of J.E. Hanger, Inc. of Georgia
("JEH") in 1996, the Company assumed the unfunded deferred compensation plan
that had been established for certain key JEH officers. The plan accrues
benefits ratably over the period of active employment from the time the
contract is entered into to the time the participant retires. Participation
had been determined by JEH's Board of Directors. The Company has purchased
individual life insurance contracts with respect to each employee covered by
this plan. The Company is the owner and beneficiary of the insurance
contracts. The accrual related to the deferred compensation arrangements
amounted to approximately $2.1 million and $2.0 million at December 31, 1999
and 2000, respectively.
NOTE K - COMMITMENTS AND CONTINGENT LIABILITIES
The Company is subject to legal proceedings and claims which arise in the
ordinary course of its business, including claims related to alleged
contingent additional payments under business purchase agreements. Many of
these legal proceedings and claims existed in the NovaCare O&P business prior
to the Company's acquisition of NovaCare O&P. In the opinion of management,
the amount of ultimate liability, if any, with respect to these actions will
not have a materially adverse effect on the financial position, liquidity or
results of operations of the Company.
On November 28, 2000, a class action complaint (Norman Ottmann v. Hanger
Orthopedic Group, Inc., Ivan R. Sabel and Richard A. Stein; Civil Action No.
00CV3508) was filed against us in the United States District Court for the
District of Maryland on behalf of all purchasers of our common stock from
November 8, 1999 through and including January 6, 2000. The complaint also
names as defendants Ivan R. Sabel, our Chairman of the Board, President and
Chief Executive Officer, and Richard A. Stein, our former Chief Financial
Officer, Secretary and Treasurer.
The complaint alleges that during the above period of time, the
defendants violated Section 10(b) and 20(a) of the Securities Exchange Act of
1934 by, among other things, knowingly or recklessly making material
F-20
misrepresentations concerning our financial results for the quarter ended
September 30, 1999, and the progress of our 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 our common stock. The plaintiff seeks to recover damages
on behalf of all of the class members.
We believe that the allegations have absolutely no merit and plan to
vigorously defend the lawsuit.
NOTE L - OPERATING LEASES
The Company leases office space under noncancellable operating leases.
Future minimum rental payments, by year and in the aggregate, under operating
leases with terms of one year or more consist of the following at December 31,
2000:
2001 $24,284
2002 17,959
2003 14,061
2004 10,120
2005 7,005
Thereafter 10,994
----------
$84,423
Rent expense was approximately $6,283, $14,821 and $23,716 for the years
ended December 31, 1998, 1999 and 2000, respectively.
NOTE M - PENSION AND PROFIT SHARING PLANS
Previously the Company had a separate defined contribution profit sharing
and 401(k) plan ("JEH Plan") covering all the employees of JEH, a wholly-owned
subsidiary of the Company acquired November 1, 1996. On this date, the Company
froze the JEH Plan such that no new employees of JEH were able to participate.
On January 1, 1998 the JEH Plan was merged into the Company's 401(k) Savings
and Retirement Plan.
Hanger acquired NovaCare O&P in July 1999. The NovaCare O&P employees
were allowed to participate in a 401(k) plan with NovaCare, Inc.
The NovaCare O&P employee assets were transferred to Hanger's 401(k) fund
manager in August 1999. The funds were transferred by executing a partial plan
merger. The NovaCare O&P employees were able to continue making 401(k)
contributions and were able to change their investment allocations.
F-21
The Company maintains a 401(k) Savings and Retirement plan to cover all
of the employees of the Company. The Company may make discretionary
contributions. Under this 401(k) plan, employees may defer such amounts of
their compensation up to the levels permitted by the Internal Revenue Service.
During 1999 and 2000, the Company made contributions of $923.0 and $1.4
million to this plan, respectively.
NOTE N - REDEEMABLE PREFERRED STOCK
The Company has 10.0 million authorized shares of preferred stock, par
value $.01 per share, which may be issued in various classes with different
characteristics.
During 1999, the Mandatorily Redeemable Preferred Stock Class F, of which
no shares had been issued, was retired. The Company issued $60.0 million of 7%
Redeemable Preferred Stock on July 1, 1999 in connection with our acquisition
of NovaCare O&P. The 60.0 million outstanding shares of 7% Redeemable
Preferred Stock are convertible into shares of our non-voting common stock at
a price of $16.50 per share, subject to adjustment. The Company is entitled to
require that the 7% Redeemable Preferred Stock be converted into non-voting
common stock on and after July 2, 2002, if the average closing price of the
common stock for 20 consecutive trading days is equal to or greater than 175%
of the conversion price. The 7% Redeemable Preferred Stock will be mandatorily
redeemable on July 1, 2010 at a redemption price equal to the liquidation
preference plus all accrued and unpaid dividends. In the event of a change in
control of our company, we must offer to redeem all of the outstanding 7%
Redeemable Preferred Stock at a redemption price equal to 101% of the sum of
the per share liquidation preference thereof plus all accrued and unpaid
dividends through the date of payment. The 7% Redeemable Preferred Stock
accrues annual dividends, compounded quarterly, equal to 7%, is subject to put
rights and will not require principal payments prior to maturity on July 1,
2010.
NOTE O - WARRANTS AND OPTIONS
Warrants
In November 1996, the Company issued warrants for 1.6 million shares of
Common Stock to the holders of certain notes. In August 1997, the Company
repaid these notes with the proceeds from a public offering. In accordance
with the note agreement, warrants for 880,000 shares were terminated. The
remaining warrants for 720,000 shares provide that the noteholders may
purchase 418,400 shares and 301,600 shares for $4.01 and $6.375, respectively.
The warrants are exercisable through November 1, 2004. In November 1998,
150,800 warrants were exercised which resulted in the issuance of 105,800
shares. Also, in November 1998, warrants for 209,200 shares were exercised
which resulted in the issuance of 169,900 shares.
At December 31, 2000, warrants to purchase 830,650 shares at prices
ranging from $2.44 to $7.65 per share were outstanding.
F-22
Options
Under the Company's 1991 Stock Option Plan ("SOP"), 8.0 million shares of
Common Stock are authorized for issuance under options that may be granted to
employees. The number of shares available for grant at December 31, 1999 and
2000 was 4.5 million and 3.1 million, respectively. Under the SOP, options may
be granted at an exercise price not less than the fair market value of the
Common Stock on the date of grant. Vesting and expiration periods are
established by the Compensation Committee of the Board of Directors and
generally vest three years following grant and generally expire eight to ten
years after grant.
Under the Company's 1993 Non-Employee Director Stock Option Plan, 250,000
shares of Common Stock are authorized for issuance to directors of the Company
who are not employed by the Company or any affiliate of the Company. Under
this plan, an option to purchase 5,000 shares of Common Stock is granted
automatically on an annual basis to each eligible director on the third
business day following the date of each Annual Meeting of Stockholders of the
Company at which the eligible director is elected. The exercise price of each
option is equal to 100% of the fair market value of the Common Stock on the
date of grant. Each option vests at the rate of 25% each year for the first
four years after the date of grant of the option and each such option expires
ten years from the date of grant; provided, however, that in the event of
termination of a director's service other than by reason of total and
permanent disability or death, then the outstanding options of such holder
expire three months after such termination. Outstanding options remain
exercisable for one year after termination of service by reason of total and
permanent disability or death. The number of shares that remain available for
grant at December 31, 1999 and 2000 were 76.3 and 49.5, respectively.
In addition to the SOP, non-qualified options may be granted with
exercise prices that are less than the current market value. Accordingly,
compensation expense for the difference between current market value and
exercise price is recorded over the vesting period.
The following is a summary of option transactions and exercise prices:
Stock Option Plan Non-Employee Director Stock Option Plan
---------------------------------- ---------------------------------------
Price Weighted Price Weighted
Shares Per Share Average Shares Per Share Average
Outstanding at
December 31, 1997 1,556,383 $ 2.75 to $13.25 7.42 200,625 $ 3.00 to $12.00 7.27
========== ========
Granted 258,750 $ 13.31 to $22.50 19.78 35,000 $ 18.63 18.63
Terminated (57,424) $ 4.13 to $17.38 10.32 (9,000) $ 3.00 to $ 8.75 6.28
Exercised (302,476) $ 2.75 to $12.25 5.68 (57,750) $ 4.38 to $12.00 11.05
---------- --------
Outstanding at
December 31, 1998 1,455,233 $ 2.75 to $22.50 9.88 168,875 $ 3.00 to $18.63 8.38
========== ========
Granted 1,225,000 $ 10.25 to $20.81 14.72 35,000 $ 10.25 to $20.81 14.70
Terminated (28,424) $ 4.13 to $22.50 13.01 (42,500) $ 3.00 to $18.63 6.92
Exercised (229,621) $ 2.75 to $13.25 6.94 (625) $ 6.52 to $ 6.52 6.52
Outstanding at
December 31, 1999 2,422,188 $ 2.75 to $22.50 12.57 160,750 $ 3.00 to $20.81 10.00
========== ========
Granted 1,304,497 $ 4.63 to $ 5.19 4.63 35,000 $ 5.19 5.19
Terminated (568,492) $ 4.13 to $22.50 8.26 (8,250) $ 6.00 6.00
Outstanding at
December 31, 2000 3,158,193 $ 2.75 to $22.00 9.54 187,500 $ 3.00 to $18.63 9.40
========== ========
Vested at December 31,
2000 1,188,951 105,000
========== ========
F-23
The Company applies APB Opinion 25 "Accounting for Stock Issued to
Employees", and related Interpretations in accounting for its plans.
Historically, the Company granted stock options at exercise prices equal to
the fair market value of the stock on the date of grant for fixed stock
options. Accordingly, no compensation cost has been recognized for its fixed
stock option plans. Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value at the grant dates
for awards under those plans consistent with the method set forth in SFAS 123,
"Accounting for Stock-Based Compensations," the Company's net income and
earnings per share would have been reduced to the unaudited pro forma amounts
indicated below:
1998 1999 2000
---- ---- ----
Net Income: As reported $13,840 $10,986 $(13,996)
Pro Forma 12,433 7,731 (19,558)
Diluted Income Per
Common Share: As reported $0.75 $0.44 ($0.98)
Pro Forma $0.67 $0.28 ($1.27)
The fair value for these options was estimated at the date of grant using
a Black-Scholes option pricing model with the following weighted average
assumptions for 1998, 1999 and 2000:
1998 1999 2000
---- ---- ----
Expected term 5 5 5
Volatility factor 59% 46% 58%
Risk free interest rate 5.1% 5.7% 6.7%
Dividend yield 0% 0% 0%
Fair value $10.87 $7.00 $2.64
F-24
The following table summarizes information concerning outstanding and
exercisable options as of December 31, 2000:
Options Outstanding Options Exercisable
--------------------------------------------------------------------------------------
Range of Exercise Number of Options Weighted Average Number of Options Weighted Average
Prices and Awards Remaining Exercise Price and Awards Exercise Price
------------------------------------------------------------------------------------------------------------------------------
Life (Years)
$ 2.810 to $ 3.500 59,908 4.85 $ 3.24 59,908 $ 3.24
$ 4.125 to $ 4.125 34,589 5.22 $ 4.13 34,589 $ 4.13
$ 4.375 to $ 6.000 1,320,510 8.71 $ 4.75 122,512 $ 5.85
$ 6.125 to $ 6.125 396,773 5.88 $ 6.13 371,773 $ 6.13
$ 6.250 to $ 6.250 5,000 2.70 $ 6.25 5,000 $ 6.25
$ 8.500 to $ 8.750 28,334 6.42 $ 8.72 22,084 $ 8.71
$10.250 to $12.500 252,539 6.79 $11.34 233,664 $11.34
$13.250 to $13.875 120,375 6.88 $13.35 81,700 $13.34
$14.000 to $14.750 723,750 8.46 $14.35 188,440 $14.35
$16.500 to $18.625 234,915 8.14 $16.89 89,115 $17.02
$20.000 to $22.500 169,000 7.96 $22.22 85,166 $22.27
------------------ --------- ----- ------ ---------- ------
$ 2.810 to $22.500 3,345,693 7.90 $ 9.53 1,293,951 $10.36
NOTE P - SEGMENT AND RELATED INFORMATION
Using the guidelines set forth in SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information", the Company has identified
three 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 income from
operations before depreciation and amortization. EBITDA is not a measure of
performance under Generally Accepted Accounting Principles ("GAAP"). While
EBITDA should not be considered in isolation or as a substitute for net
income, cash flows from operating activities and other income or cash flow
statement data prepared in accordance with GAAP, or as a measure of
profitability or liquidity, management understands that EBITDA is customarily
used as a criteria in evaluating heath care companies. Moreover, substantially
all of the Company's financing agreements contain covenants in which EBITDA is
used as a measure of financial performance. EBITDA is presented for each
reported segment before reclassifications between EBITDA and other income
(expense) made for external reporting purposes.
The reportable segments are: (i) practice management and patient-care
centers; (ii) manufacturing; and (iii) distribution. These are described
further below:
Practice Management and Patient-Care Centers - This segment consists of the
Company's owned and operated O&P patient-care centers as well as 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. OPNET is a national managed care
agent for O&P services and a patient referral clearing house.
F-25
Manufacturing - This segment consists of the manufacture and fabrication of
O&P components and finished patient-care products for both the O&P industry
and the Company's own patient-care practices.
Distribution - This segment distributes orthotic and prosthetic products and
components to both the O&P industry and the Company's own patient-care
practices.
The accounting policies of the segments are the same as those described in the
summary of "Significant Accounting Policies."
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
practice management and patient-care centers segment and were made at prices
which approximate market values .
F-26
Practice
Management
And Patient
Care Centers Manufacturing Distribution Other Total
------------ ------------- ------------ ----- ------
2000
Net Sales
Customers $447,470 $ 9,562 $28,999 $ --- $486,031
Intersegments -- 15,103 51,427 (66,530) ---
EBITDA 75,446 (3,474) 6,683 (21,511) 57,144
Total assets 493,418 11,255 20,823 236,322 761,818
Capital Expenditures 6,017 1,234 114 2,480 9,845
1999
Net Sales
Customers $307,477 $10,263 $29,086 $ --- $346,826
Intersegments --- 6,050 37,416 (43,466) ---
EBITDA 65,248 485 8,002 (9,628) 64,107
Total assets 142,462 15,689 16,296 575,634 750,081
Capital Expenditures 7,312 1,573 423 3,290 12,598
1998
Net Sales
Customers $152,276 $ 8,548 $27,046 --- $187,870
Intersegments --- 2,576 18,684 $(21,260) ---
EBITDA 32,351 433 4,174 (6,451) 30,507
Total assets 57,945 8,947 9,796 129,260 205,948
Capital Expenditures 1,698 576 232 353 2,859
F-27
The following table reconciles each reportable segment's EBITDA to
consolidated income before income taxes:
Practice
Management
And Patient
Care Centers Manufacturing Distribution Other Total
------------ ------------- ------------ ----- ------
2000
EBITDA $ 75,446 $ (3,474) $6,683 $ (21,511) $ 57,144
Restructuring Costs
and (1,047) (13) (6) (1,298) (2,364)
Integration Expense
Depreciation and
Amortization (19,868) (2,065) (300) (1,095) (23,328)
Interest expense, net (50,423) (28) 0 3,379 (47,072)
Other income (expense) (164) 309 (6) (12) 127
---------- ---------- -------- ----------- ---------
Income before taxes $ 3,944 $ (5,271) $6,371 $ (20,537) $(15,493)
========== ========== ======= =========== =========
1999
EBITDA $ 65,248 $ 485 $8,002 $ (9,628) $ 64,107
Restructuring Costs
and (5,763) (430) (60) (87) (6,340)
Integration Expense
Depreciation and
Amortization (11,925) (1,640) (187) (306) (14,058)
Interest expense, net (2,003) (17) (2) (20,155) (22,177)
Other income (expense) (153) (88) 6 (117) (352)
---------- ---------- ------- ----------- ---------
Income before taxes $ 45,404 $ (1,690) $7,759 $ (30,293) $ 21,180
========== ========== ======= =========== =========
1998
EBITDA $ 32,351 $ 433 $4,174 $ (6,451) $ 30,507
Depreciation and
Amortization (4,321) (1,009) (270) (182) (5,782)
Interest expense, net (1,538) (48) 6 (322) (1,902)
Other income (expense) 508 (76) 475 (274) 633
---------- ---------- ------- ----------- ---------
Income before taxes $ 27,000 $ (700) $4,385 $ (7,229) $ 23,456
========== ========== ======= =========== =========
The following table presents the details of "Other" EBITDA for the years ended
December 31:
1998 1999 2000
---- ---- ----
Corporate general and
administrative expenses $ 6,399 $ 9,549 $ 21,511
Other 52 79 ---
--------- ---------- ---------
$ 6,451 $ 9,628 $ 21,511
========= ========= =======
F-28
The following table presents the details of "Other" total assets at December
31:
1998 1999 2000
---- ---- ----
Corporate intercompany receivable from
Practice Management and
Patient-Care Centers segment $ 93,713 $533,978 $159,416
Corporate intercompany receivable from
Manufacturing segment 20,217 16,277 21,926
Corporate intercompany receivable from
Distribution segment 3,788 1,469 (588)
Other 11,542 23,910 55,568
-------- -------- ---------
$129,260 $575,634 $236,322
========= ======== =========
"Other" total assets presented in the preceding table primarily consist of
corporate cash and deferred taxes not specifically identifiable to the
reportable segments.
The Company's foreign and export sales and assets located outside of the
United States are not significant. Additionally, no single customer accounted
for more than 10% of revenues in 1998, 1999 or 2000.
F-29
HANGER ORTHOPEDIC GROUP, INC.
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS
BALANCE AT CHARGED TO IMPACT OF BALANCE AT
BEGINNING COSTS AND ACQUIRED END OF
YEAR CLASSIFICATION OF YEAR EXPENSES COMPANIES DEDUCTIONS YEAR
---- -------------- ---------- ----------- ----------- ---------- ---------
2000 Allowance for
doubtful accounts $17,866 $23,620 $ 114 $18,595 $23,005
Inventory Reserves $ 2,281 $ 120 $ 73 $ 76 $ 2,398
1999 Allowance for
doubtful accounts $ 8,022 $15,046 $8,811 $14,013 $17,866
Inventory Reserves $ 4,849 $ --- $ 528 $ 3,096 $ 2,281
1998 Allowance for
doubtful accounts $ 4,871 $ 7,510 $1,125 $ 5,484 $ 8,022
Inventory Reserves $ 1,500 $ 2,202 $1,147 $ --- $ 4,849
S-1