SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 1-10670
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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 (IRS Employer Identification No.)
incorporation or organization)
Two Bethesda Metro Center, Suite 1200, Bethesda, MD 20814
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
(301) 986-0701
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Former name, former address and former fiscal year,
if changed since last report.
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
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2 of the Exchange Act): Yes X No
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As of May 9, 2003, 20,685,268 shares of common stock, $.01 par value per
share were outstanding.
HANGER ORTHOPEDIC GROUP, INC.
INDEX
Page No.
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Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - March 31, 2003
(unaudited) and December 31, 2002 1
Consolidated Statements of Operations for the Three
Months Ended March 31, 2003 and 2002 (unaudited) 3
Consolidated Statements of Cash Flows for the Three
Months Ended March 31, 2003 and 2002 (unaudited) 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk 27
Item 4. Controls and Procedures 28
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 29
SIGNATURES 30
CERTIFICATIONS 31
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share amounts)
March 31, December 31,
2003 2002
-------------- ----------------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 13,679 $ 6,566
Accounts receivable, less allowances for doubtful accounts
of $7,955 and $8,649 in 2003 and 2002, respectively 105,505 107,604
Inventories 55,283 56,454
Prepaid expenses, other assets, and income taxes receivable 6,236 15,432
Deferred income taxes 6,586 6,586
-------------- ----------------
Total current assets 187,289 192,642
-------------- ----------------
PROPERTY, PLANT AND EQUIPMENT
Land 3,743 3,743
Buildings 6,726 6,715
Machinery and equipment 17,480 17,110
Computer and software 19,608 17,990
Furniture and fixtures 10,479 10,353
Leasehold improvements 19,799 18,671
-------------- ----------------
Property, plant, and equipment, gross 77,835 74,582
Less accumulated depreciation and amortization 41,255 39,036
-------------- ----------------
Property, plant, and equipment, net 36,580 35,546
-------------- ----------------
INTANGIBLE ASSETS
Excess cost over net assets acquired 454,289 453,988
Patents and other intangible assets, $10,232 and $10,232
less accumulated amortization of $4,629 and $4,404
in 2003 and 2002, respectively 5,604 5,828
-------------- ----------------
Total intangible assets 459,893 459,816
-------------- ----------------
OTHER ASSETS
Debt issuance costs, net 13,146 13,741
Other assets 9,454 10,481
-------------- ----------------
Total other assets 22,600 24,222
-------------- ----------------
TOTAL ASSETS $ 706,362 $ 712,226
============== ================
The accompanying notes are an integral part of the consolidated financial statements.
1
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share amounts)
March 31, December 31,
2003 2002
--------------- ----------------
(unaudited)
LIABILITIES, REDEEMABLE PREFERRED STOCK
AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt $ 3,536 $ 5,181
Accounts payable 11,559 14,876
Accrued expenses and income taxes payable 5,720 5,460
Accrued interest payable 7,253 7,507
Accrued compensation related cost 19,639 32,950
--------------- ----------------
Total current liabilities 47,707 65,974
LONG-TERM LIABILITES
Long-term debt, less current portion 384,894 378,101
Deferred income taxes 22,965 22,965
Other liabilities 1,331 1,578
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Total long-term liabilities 409,190 402,644
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Total liabilities 456,897 468,618
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PREFERRED STOCK
7% Redeemable Convertible Preferred Stock, liquidation preference
$1,000 per share 77,298 75,941
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COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Common stock, $.01 par value; 60,000,000 shares authorized,
20,549,435 shares and 20,277,180 shares issued and
outstanding in 2003 and 2002, respectively 205 203
Additional paid-in capital 150,664 150,287
Retained earnings (accumulated deficit) 21,954 17,833
--------------- ----------------
172,823 168,323
Treasury stock, cost (133,495 shares) (656) (656)
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Total shareholders' equity 172,167 167,667
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TOTAL LIABILITIES, REDEEMABLE PREFERRED STOCK
AND SHAREHOLDERS' EQUITY $ 706,362 $ 712,226
=============== ================
The accompanying notes are an integral part of the consolidated financial statements.
2
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended March 31,
(Dollars in thousands, except share and per share amounts)
2003 2002
-------------- --------------
(unaudited)
Net sales $ 126,128 $ 123,510
Cost of goods sold (exclusive of depreciation and amortization) 60,690 59,537
-------------- --------------
Gross profit 65,438 63,973
Selling, general and administrative 44,766 44,777
Depreciation and amortization 2,453 2,784
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Income from operations 18,219 16,412
Interest expense, net 9,096 9,079
Extinguishment of debt - 4,686
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Income before taxes 9,123 2,647
Provision for income taxes 3,645 1,125
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Net income 5,478 1,522
Preferred stock dividend and accretion 1,357 1,266
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Net income applicable to common stock $ 4,121 $ 256
============== ==============
Basic Per Common Share Data
Net income applicable to common stock $ 0.20 $ 0.01
============== ==============
Shares used to compute basic per common share amounts 20,408,262 19,137,586
============== ==============
Diluted Per Common Share Data
Net income applicable to common stock $ 0.19 $ 0.01
============== ==============
Shares used to compute diluted per common share amounts 21,990,343 21,642,231
============== ==============
The accompanying notes are an integral part of the consolidated financial statements.
3
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31,
(Dollars in thousands)
2003 2002
------------ ------------
(unaudited)
Cash flows from operating activities:
Net income $ 5,478 $ 1,522
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Extinguishment of debt - 4,686
Loss on disposal of assets - 413
Provision for bad debts 4,763 5,158
Depreciation and amortization 2,453 2,784
Amortization of debt issuance costs 595 513
Changes in assets and liabilities, net of effects of acquired companies:
Accounts receivable (2,664) (5,495)
Inventories 1,171 1,632
Prepaid expenses, other assets, and income taxes receivable 10,558 (1,603)
Other assets 73 (181)
Accounts payable (3,317) (6,080)
Accrued expenses, interest, and income taxes payable (1,355) 5,734
Accrued compensation related costs (13,311) (11,329)
Other liabilities (247) (765)
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Net cash provided by (used in) operating activities 4,197 (3,011)
----------- ------------
Cash flows from investing activities:
Purchase of property, plant and equipment (3,303) (1,626)
Acquisitions and earouts (301) (1,226)
Proceeds from sale of certain assets 41 1,492
----------- ------------
Net cash used in investing activities (3,563) (1,360)
----------- ------------
Cash flows from financing activities:
Borrowings under revolving credit agreement 16,000 -
Repayments under revolving credit agreement (8,000) (34,300)
Proceeds from sale of Senior Notes - 200,000
Repayment and termination of bank loans - (153,587)
Scheduled repayment of long-term debt (1,900) (3,132)
Increase in financing costs - (8,480)
Proceeds from issuance of Common Stock 379 729
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Net cash provided by financing activities 6,479 1,230
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Increase (decrease) in cash and cash equivalents 7,113 (3,141)
Cash and cash equivalents at beginning of year 6,566 10,043
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Cash and cash equivalents at end of year $ 13,679 $ 6,902
=========== ============
The accompanying notes are an integral part of the consolidated financial statements.
4
HANGER ORTHOPEDIC GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in accordance
with Rule 10-01 of Regulation S-X. They do not include all of the information
and notes required by generally accepted accounting principles ("GAAP") for
complete financial statements. In the opinion of management, all adjustments
considered necessary (consisting solely of normal recurring adjustments) for a
fair presentation of the financial statements have been included. Certain
reclassifications of the prior year's data have been made to improve
comparability.
These financial statements should be read in conjunction with the financial
statements of Hanger Orthopedic Group, Inc. (the "Company") and notes thereto
included in the Annual Report on Form 10-K for the year ended December 31, 2002,
filed by the Company with the Securities and Exchange Commission.
NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES
Use of Estimates
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Inventories
Inventories, which consist principally of purchased parts and work in process,
are stated at the lower of cost or market using the first-in, first-out (FIFO)
method. The Company calculates cost of goods sold in accordance with the gross
profit method. The Company bases the estimates used in applying the gross profit
method on the actual results of the most recently completed fiscal year and
other factors affecting cost of goods sold during the current reporting periods.
Estimated cost of goods sold during the period is adjusted when the annual
physical inventory is taken. The Company treats these adjustments as changes in
accounting estimates in accordance with the provisions of Accounting Principles
Board Opinion ("APB") 20.
Stock Based Compensation
At March 31, 2003, the Company has multiple stock-based employee compensation
plans and has outstanding non-qualified options held by employees. Stock-based
compensation is accounted for using the intrinsic-value-based method in
accordance with APB 25, Accounting for Stock Issued to Employees, and related
Interpretations. No stock-based employee compensation expense is reflected in
net income (loss) as all options granted under these plans and the non-qualified
options
5
NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES (CONTINUED)
Stock Based Compensation (continued)
granted to employees had an exercise price equal to the market value of the
underlying common stock on the date of grant. The following table illustrates
the effect on net income and earnings per share if the Company had applied the
fair value recognition provisions of Statement of Financial Accounting Standards
("SFAS") 123, Accounting for Stock-Based Compensation, to stock-based employee
compensation:
Three Months Ended
March 31,
----------------------------
2003 2002
---- ----
(In thousands, except per share amounts)
Net income applicable to common stock, as reported $ 4,121 $ 256
Deduct: total stock-based employee compensation
expense determined under fair value method for all
awards, net of related tax effects (638) (628)
----------- ------------
Pro forma net income (loss) applicable to common stock $ 3,483 $ (372)
=========== ============
Earnings (loss) per share:
Basic - as reported $ 0.20 $ 0.01
Basic - pro forma $ 0.17 $ (0.02)
Diluted - as reported $ 0.19 $ 0.01
Diluted - pro forma $ 0.16 $ (0.02)
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:
Three Months Ended
March 31,
---------------------------
2003 2002
---- ----
Expected term 5 5
Volatility factor 74% 71%
Risk free interest rate 2.9% 5.8%
Dividend yield 0.00% 0.00%
For the quarters ended March 31, 2003 and 2002, the Company granted aggregate
options to purchase 110,332 and 405,000 shares of the Company's common stock,
respectively. The weighted average fair value of each option granted was $7.40
per share for 2003 and $6.80 per share for 2002.
6
NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES (CONTINUED)
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 basis
of the Company's reportable segments. SFAS 131 also requires disclosure about
products and services, geographic areas and major customers. The description of
the Company's reportable segments and the disclosure of segment information
pursuant to SFAS 131 are presented in Note I.
New Accounting Standards
In April 2002, the Financial Accounting Standard Board ("FASB") issued Statement
of Financial Accounting Standards 145, Rescission of FASB Statements 4, 44, and
64, Amendment of FASB Statement 13, and Technical Corrections ("SFAS 145").
Under SFAS 145, gains and losses from the early extinguishment of debt are no
longer classified as extraordinary items, unless they satisfied the criteria in
Accounting Principles Board Opinion 30 ("APB 30") where extraordinary items are
stated to be distinguishable by their unusual nature and by the infrequency of
their occurrence. Any gain or loss on extinguishment of debt that was classified
as an extraordinary item in prior periods presented that does not meet the
criteria in APB 30 for classification as an extraordinary item has been
reclassified. In addition, under SFAS 145, certain lease modifications that have
economic effects similar to sale-leaseback transactions are to be accounted for
in the same manner as sale-leaseback transactions. SFAS 145 was effective for
fiscal years beginning after May 15, 2002. SFAS 145 was adopted by the Company
on January 1, 2003 and resulted in a reclassification of existing extraordinary
losses on the early extinguishment of debt from an extraordinary item to a
non-operating item.
In July 2002, the FASB issued Statement of Financial Accounting Standards 146,
Accounting for Costs Associated with Exit or Disposal Activities ("SFAS 146").
Under SFAS 146, costs associated with exit or disposal activities are to be
recognized when they are incurred rather than at the date of a commitment to an
exit or disposal plan. Such costs include lease termination costs and certain
employee severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. SFAS 146 is to be
applied prospectively to exit or disposal activities initiated after December
31, 2002. SFAS 146 has not had a material effect on the Company's financial
statements.
In December 2002, the FASB issued Statement of Financial Accounting Standards
148, Accounting for Stock-Based Compensation - Transition and Disclosure, an
amendment of SFAS Statement 123 ("SFAS 148"). SFAS 148 amends SFAS 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method of
7
NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES (CONTINUED)
New Accounting Standards (continued)
accounting for stock-based compensation. The Company continues to use the
intrinsic-value-based method of accounting for stock-based employee compensation
as prescribed by APB Opinion 25. In addition, SFAS 148 amends the disclosure
requirements of SFAS 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. The
Company adopted the disclosure provisions of SFAS 148 as of December 31, 2002.
The adoption had no material impact on the Company's financial statements.
In November 2002, the FASB issued FASB Interpretation 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others ("FIN 45"). FIN 45 requires that upon issuance of a
guarantee, a guarantor must recognize a liability for the fair value of an
obligation assumed under a guarantee. FIN 45 also requires additional
disclosures by a guarantor in its interim and annual financial statements about
the obligations associated with guarantees issued. The recognition provisions of
FIN 45 are effective for any guarantees that are issued or modified after
December 31, 2002. The disclosure requirements are effective for the Company's
quarter ended March 31, 2003. The adoption of this statement had no material
effect on the Company's financial statements.
NOTE C - SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION
The following are the supplemental disclosure requirements for the statements of
cash flows:
Three Months Ended
March 31,
----------------------------
(In thousands) 2003 2002
---- ----
Cash paid (received) during the period for:
Interest $ 8,778 $ 11,286
Income taxes $ (8,122) $ 632
Non-cash financing and investing activities:
Preferred stock dividends declared and accretion $ 1,357 $ 1,266
NOTE D - ACQUISITIONS
The Company did not acquire any companies during the three months ended March
31, 2003 or 2002. In April 2003, the Company acquired one orthotic and
prosthetic company.
In connection with the acquisition of NovaCare Orthotics & Prosthetics, Inc.
("NovaCare O&P") in July 1999, the Company assumed responsibility for payments
of earnouts and working capital provisions related to acquisitions made by
NovaCare O&P prior to July 1, 1999. In connection with these agreements and the
Company's acquisitions prior to 2001, the Company paid $0.3
8
NOTE D - ACQUISITIONS (CONTINUED)
million and $1.2 million in the three month periods ended March 31, 2003 and
2002, respectively. The Company has accounted for these amounts as additional
purchase price, resulting in an increase in excess cost over net assets
acquired. The Company estimates that it may pay an additional $1.1 million
related to earn-out provisions in future periods.
NOTE E - NET INCOME PER COMMON SHARE
Basic per common share amounts are computed using the weighted average number of
common shares outstanding during the period. Diluted per common share amounts
are computed using the weighted average number of common shares outstanding
during the period and dilutive potential common shares. Dilutive potential
common shares consist of stock options, stock warrants, and redeemable
convertible preferred stock and are calculated using the treasury stock method.
Income per share is computed as follows:
Three Months Ended
March 31,
---------------------------------
(In thousands, except share amounts) 2003 2002
---- ----
Net income $ 5,478 $ 1,522
Less preferred stock dividends declared and accretion (1,357) (1,266)
---------------- ------------
Net income available to common stockholders used to
compute basic and diluted per common share amounts $ 4,121 $ 256
================ ============
Shares of common stock outstanding used to compute
basic per common share amounts 20,408,262 19,137,586
Effect of dilutive options 1,582,081 2,361,525
Effect of dilutive warrants - 143,120
---------------- ------------
Shares used to compute dilutive per common share
amounts (1) 21,990,343 21,642,231
================ ============
(1) Excludes the effect of the conversion of the 7% Redeemable Convertible
Preferred Stock into common stock as it is considered anti-dilutive.
Options to purchase 1,385,498 and 1,207,212 shares of common stock were
outstanding at March 31, 2003 and 2002, respectively, and are not included in
the computation of diluted income per share for the three months ended March 31,
2003 and 2002, as these options are anti-dilutive.
9
NOTE F - INVENTORY
Inventories consist of the following:
March 31, December 31,
(In thousands) 2003 2002
---- ----
Raw materials $ 25,628 $ 26,905
Work in process 19,719 19,719
Finished goods 9,936 9,830
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$ 55,283 $ 56,454
========== ==========
NOTE G - LONG TERM DEBT
Long-term debt consists of the following:
March 31, December 31,
(In thousands) 2003 2002
---- ----
Revolving Credit Facility $ 23,000 $ 15,000
10 3/8% Senior Notes due 2009 (1) 207,445 208,398
11 1/4% Senior Subordinated Notes due 2009 150,000 150,000
Subordinated seller notes, non-collateralized net of unamortized
discount of $ 0.1 million with principal and interest payable in either
monthly, quarterly or annual installments at effective interest rates
ranging from 6% to 12.287%, maturing through January 2009 7,985 9,884
------------------------------------
388,430 383,282
Less current portion (3,536) (5,181)
------------------------------------
Total long-term debt $ 384,894 $ 378,101
====================================
(1) Includes $7.4 million and $8.4 million adjustments for March 31, 2003 and
December 31, 2002, respectively, related to the interest rate swaps.
The previously existing Revolving Credit Facility, Tranche A Term Loan
Commitment, and Tranche B Term Commitment outstanding as of December 31, 2001
were subsequently prepaid in full and the agreements were terminated on February
15, 2002.
As a result of retiring the previously existing indebtedness, the Company wrote
off $4.7 million in unamortized debt issuance costs that had previously been
included in Other Assets. These costs are included in Extinguishment of Debt for
the three months ended March 31, 2002. As discussed in Note B, under "New
Accounting Standards", this amount was previously reported as an extraordinary
item, net of a tax benefit of $1.8 million. The gross amount has been
reclassified to a non-operating item and the tax benefit has been reclassified
into the provision for income taxes as a result of the Company's adoption of
SFAS 145.
10
NOTE G - LONG TERM DEBT (CONTINUED)
On February 15, 2002, the Company sold $200.0 million principal amount of its 10
3/8% Senior Notes due 2009 (the "Senior Notes") and established a new $75.0
million senior secured revolving line of credit (the "New Revolving Credit
Facility"). The Senior Notes were issued under an indenture, dated as of
February 15, 2002, with Wilmington Trust Company, as trustee. The Company used
the $194.0 million net proceeds from the sale of the Senior Notes, along with
approximately $36.9 million from the New Revolving Credit Facility, to retire
approximately $228.4 million of indebtedness outstanding under the Company's
previously existing revolving credit and term loan facilities, plus related fees
and expenses.
As of March 31, 2003, the Company had available borrowings of $52.0 million
under the New Revolving Credit Facility.
On April 30, 2003, the total available borrowings under the New Revolving Credit
Facility were increased from $75.0 million to $100.0 million and the
administrative agent was changed from BNP Paribas to GE Capital Corporation.
NOTE H - COMMITMENTS AND CONTINGENT LIABILITIES
Commitments
In October 2001, the Company entered into a Supply Agreement with United States
Manufacturing Company ("USMC"), under which it agreed to purchase certain
products and components for use solely by the Company's patient-care centers
during a five-year period following the date of the agreement. The Company
satisfied its obligation to purchase from USMC at least $7.5 million of products
and components during the first year following the date of the agreement.
Accordingly, on November 1, 2002, the escrow agent released $1.0 million in
escrowed funds to the Company for the satisfaction of such first-year purchase
obligations.
In addition, the Company is obligated to purchase from USMC at least $8.5
million and $9.5 million of products and components during the second and third
years following the agreement, respectively, subject to certain adjustments.
However, in the event purchases during each of the fourth and fifth years are
less than approximately $8.7 million, the Company shall pay USMC an amount equal
to $0.1 million multiplied by the number of $1.0 million units by which actual
purchases during each of the fourth and fifth years are less than approximately
$8.7 million.
Contingencies
The Company is subject to legal proceedings and claims which arise in the
ordinary course of its business, including claims related to alleged contingent
additional payments under business purchase agreements. 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.
11
NOTE H - COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)
Contingencies (Continued)
On November 28, 2000, a class action complaint (Norman Ottmann v. Hanger
Orthopedic Group, Inc., Ivan R. Sabel and Richard A. Stein; Civil Action No.
00CV3508) was filed against the Company in the United States District Court for
the District of Maryland on behalf of all purchasers of our common stock from
November 8, 1999 through and including January 6, 2000. The complaint also names
as defendants Ivan R. Sabel, the Company's Chairman of the Board and Chief
Executive Officer (and then President), and Richard A. Stein, the Company's
former Chief Financial Officer, Secretary and Treasurer (the "Class Action
Lawsuit").
The complaint alleges that during the above period of time, the defendants
violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934 by,
among other things, knowingly or recklessly making material misrepresentations
concerning the Company's financial results for the quarter ended September 30,
1999, and the progress of the Company's efforts to integrate the
recently-acquired operations of NovaCare O&P. The complaint further alleges that
by making those material misrepresentations, the defendants artificially
inflated the price of the Company's common stock. The plaintiff seeks to recover
damages on behalf of all of the class members. The Class Action Lawsuit has been
dismissed by the District Court for failure to comply with statutory
requirements. On November 5, 2002, plaintiffs filed a notice of appeal to the
United States Court of Appeals for the Fourth Circuit.
The Company believes that the allegations have no merit and is vigorously
defending the Class Action Lawsuit. Additionally, the Company believes that it
is remote that any claims would result from this action and therefore, no
related liabilities have been recorded.
Guarantees and Indemnifications
In the ordinary course of its business, the Company may enter into service
agreements with service providers in which it agrees to indemnify or limit the
service provider against certain losses and liabilities arising from the service
provider's performance of the agreement. In connection with the provisions of
FASB Interpretation 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others, the Company
has reviewed its existing contracts containing indemnification or clauses of
guarantees. The Company does not believe that its obligation under such
agreements will result in any material liability.
12
NOTE I - SEGMENT AND RELATED INFORMATION
The Company has identified two reportable segments in which it operates based on
the products and services it provides. The Company evaluates segment performance
and allocates resources based on the segments' EBITDA. EBITDA is defined as net
income (loss) before extraordinary item, interest, taxes, depreciation and
amortization and unusual charges. EBITDA, as used by management to evaluate
segment performance, is not a measure of performance under GAAP. Other EBITDA
not directly attributable to reportable segments is primarily related to
corporate general and administrative expenses.
The two reportable segments are: (i) patient-care centers and (ii) distribution.
The reportable segments are described further below:
Patient-care centers - This segment consists of the Company's owned and operated
O&P patient-care centers, fabrication centers of O&P components and OPNET. The
patient-care centers provide services to design and fit orthotic and prosthetic
devices to patients. These centers also instruct patients in the use, care and
maintenance of the devices. Fabrication centers are involved in the fabrication
of O&P components for both the O&P industry and the Company's own patient-care
practices. OPNET is a national managed care agent for O&P services and a patient
referral clearing house.
Distribution - This segment distributes O&P products and components to both the
O&P industry and the Company's own patient-care practices.
The accounting principles of the segments are the same as those described in the
summary of "Significant Accounting Principles."
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 distribution segment to the patient-care centers segment and
were made at prices which approximate market values.
13
NOTE I - SEGMENT AND RELATED INFORMATION (CONTINUED)
Patient-
Care Other and
(In thousands) Centers Distribution Eliminations Total
------- ------------ ------------ -----
Three Months Ended March 31, 2003
- ---------------------------------
Net sales
Customers $ 118,110 $ 8,018 $ - $ 126,128
Intersegment - 13,941 (13,941) -
EBITDA 23,236 2,563 (5,127) 20,672
Three Months Ended March 31, 2002
- ---------------------------------
Net sales
Customers $ 116,947 $ 6,563 $ - $ 123,510
Intersegment - 12,399 (12,399) -
EBITDA 22,603 1,146 (4,553) 19,196
"Other" EBITDA presented in the preceding table consists of corporate general
and administrative expenses.
The following table reconciles EBITDA to consolidated net income:
Three Months Ended
March 31,
----------------------------
(In thousands) 2003 2002
---- ----
EBITDA $ 20,672 $ 19,196
Depreciation and amortization 2,453 2,784
Interest expense, net 9,096 9,079
Extinguishment of debt - 4,686
Provision for income taxes 3,645 1,125
----------- ----------
Net income $ 5,478 $ 1,522
=========== ==========
14
NOTE J - CONSOLIDATING FINANCIAL INFORMATION
The Company's Senior Notes and Senior Subordinated Notes are guaranteed fully,
jointly and severally, and unconditionally by all of the Company's current and
future domestic subsidiaries. The following is summarized condensed
consolidating financial information, as of March 31, 2003 and December 31, 2002,
and for the three month periods ended March 31, 2003 and 2002 of the Company,
segregating the parent company (Hanger Orthopedic Group, Inc.) and its guarantor
subsidiaries, as each of the Company's subsidiaries is wholly-owned.
15
NOTE J - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger
Orthopedic
Group
BALANCE SHEET - March 31, 2003 (Parent Guarantor Consolidating Consolidated
(In thousands) Company) Subsidiaries Adjustments Totals
- -------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 7,722 $ 5,957 $ - $ 13,679
Accounts receivable - 105,505 - 105,505
Inventories - 55,283 - 55,283
Prepaid expenses, other assets, and income taxes receivable 841 5,395 - 6,236
Intercompany receivable 506,921 - (506,921) -
Deferred income taxes 6,586 - - 6,586
---------------------------------------------------------------
Total current assets 522,070 172,140 (506,921) 187,289
Property, plant and equipment, net 4,666 31,914 - 36,580
Intangible assets, net - 459,893 - 459,893
Investment in subsidiaries 121,820 - (121,820) -
Other assets 20,836 1,764 - 22,600
---------------------------------------------------------------
Total assets $ 669,392 $ 665,711 $ (628,741) $ 706,362
===============================================================
LIABILITIES, REDEEMABLE PREFERRED STOCK,
AND SHAREHOLDERS' EQUITY
Current portion of long-term debt $ - $ 3,536 $ - $ 3,536
Accounts payable 623 10,936 - 11,559
Accrued expenses and income taxes payable 7,611 (1,891) - 5,720
Accrued interest payable 7,055 198 - 7,253
Accrued compensation related cost 1,202 18,437 - 19,639
---------------------------------------------------------------
Total current liabilities 16,491 31,216 - 47,707
Long-term debt, less current portion 380,445 4,449 - 384,894
Deferred income taxes 22,965 - - 22,965
Intercompany Payable - 506,921 (506,921) -
Other liabilities 26 1,305 - 1,331
---------------------------------------------------------------
Total long-term liabilities 403,436 512,675 (506,921) 409,190
---------------------------------------------------------------
Total liabilities 419,927 543,891 (506,921) 456,897
---------------------------------------------------------------
Redeemable preferred stock 77,298 - - 77,298
---------------------------------------------------------------
Common stock 205 35 (35) 205
Additional paid-in capital 150,664 7,462 (7,462) 150,664
Retained earnings 21,954 114,863 (114,863) 21,954
Treasury stock (656) (540) 540 (656)
---------------------------------------------------------------
Total shareholders' equity 172,167 121,820 (121,820) 172,167
---------------------------------------------------------------
Total liabilities, redeemable preferred stock,
and shareholders' equity $ 669,392 $ 665,711 $ (628,741) $ 706,362
===============================================================
16
NOTE J - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger
Orthopedic
Group
BALANCE SHEET - December 31, 2002 (Parent Guarantor Consolidating Consolidated
(In thousands) Company) Subsidiaries Adjustments Totals
- ------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 570 $ 5,996 $ - $ 6,566
Accounts receivable - 107,604 - 107,604
Inventories - 56,454 - 56,454
Prepaid expenses, other assets, and income taxes receivable 8,865 6,567 - 15,432
Intercompany receivable 513,802 - (513,802) -
Deferred income taxes 6,586 - - 6,586
------------------------------------------------------------
Total current assets 529,823 176,621 (513,802) 192,642
Property, plant and equipment, net 4,633 30,913 - 35,546
Intangible assets, net - 459,816 - 459,816
Investment in subsidiaries 98,258 - (98,258) -
Other assets 22,465 1,757 - 24,222
------------------------------------------------------------
Total assets $ 655,179 $ 669,107 $ (612,060) $ 712,226
============================================================
LIABILITIES, REDEEMABLE PREFERRED STOCK,
AND SHAREHOLDERS' EQUITY
Current portion of long-term debt $ - $ 5,181 $ - $ 5,181
Accounts payable 334 14,542 - 14,876
Accrued expenses 4,446 1,014 - 5,460
Accrued interest payable 7,340 167 - 7,507
Accrued compensation related cost 3,062 29,888 - 32,950
------------------------------------------------------------
Total current liabilities 15,182 50,792 - 65,974
Long-term debt, less current portion 373,398 4,703 - 378,101
Deferred income taxes 22,965 - - 22,965
Intercompany payable - 513,802 (513,802) -
Other liabilities 26 1,552 - 1,578
------------------------------------------------------------
Total long-term liabilities 396,389 520,057 (513,802) 402,644
------------------------------------------------------------
Total liabilities 411,571 570,849 (513,802) 468,618
------------------------------------------------------------
Redeemable preferred stock 75,941 - - 75,941
------------------------------------------------------------
Common stock 203 35 (35) 203
Additional paid-in capital 150,287 7,460 (7,460) 150,287
Retained earnings (accumulated deficit) 17,833 91,303 (91,303) 17,833
Treasury stock (656) (540) 540 (656)
------------------------------------------------------------
Total shareholders' equity 167,667 98,258 (98,258) 167,667
------------------------------------------------------------
Total liabilities, redeemable preferred stock,
and shareholders' equity $ 655,179 $ 669,107 $ (612,060) $ 712,226
============================================================
17
NOTE J - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger
Orthopedic
STATEMENT OF OPERATIONS Group
Three Months Ended March 31, 2003 (Parent Guarantor Consolidating Consolidated
(In thousands) Company) Subsidiaries Adjustments Totals
- -------------------------------------------------------------------------------------------------------------------------
Net sales $ - $ 126,128 $ - $ 126,128
Cost of goods sold (exclusive of depreciation
and amortization) - 60,690 - 60,690
-------------------------------------------------------------
Gross profit - 65,438 - 65,438
Selling, general and administrative 5,127 39,639 - 44,766
Depreciation and amortization 357 2,096 - 2,453
-------------------------------------------------------------
Income from operations (5,484) 23,703 - 18,219
Interest expense, net 8,953 143 - 9,096
Equity in earnings of subsidiaries 23,560 - (23,560) -
-------------------------------------------------------------
Income before taxes 9,123 23,560 (23,560) 9,123
Provision for income taxes 3,645 - - 3,645
-------------------------------------------------------------
Net income $ 5,478 $ 23,560 $ (23,560) $ 5,478
=============================================================
STATEMENT OF CASH FLOWS
Three Months Ended March 31, 2003
(In thousands)
Cash flows provided by (used in) operating activities $ 22,723 $ 5,034 $ (23,560) $ 4,197
Cash flows used in investing activities
Purchase of property, plant and equipment (390) (2,913) - (3,303)
Acquisitions and earnouts - (301) - (301)
Investment in subsidiaries (23,560) - 23,560 -
Proceeds from sale of certain assets - 41 - 41
-------------------------------------------------------------
Net cash provided by (used in) investing activities (23,950) (3,173) 23,560 (3,563)
-------------------------------------------------------------
Cash flows provided by (used in) financing activities
Borrowings under revolving credit agreement 16,000 - - 16,000
Repayments under revolving credit agreement (8,000) - - (8,000)
Scheduled repayment of long-term debt - (1,900) - (1,900)
Proceeds from issuance of common stock 379 - - 379
-------------------------------------------------------------
Net cash provided by (used in) financing activities 8,379 (1,900) - 6,479
-------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 7,152 (39) - 7,113
Cash and cash equivalents, beginning of period 570 5,996 - 6,566
-------------------------------------------------------------
Cash and cash equivalents, end of period $ 7,722 $ 5,957 $ - $ 13,679
=============================================================
18
NOTE J - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger
Orthopedic
STATEMENT OF OPERATIONS Group
Three Months Ended March 31, 2002 (Parent Guarantor Consolidating Consolidated
(In thousands) Company) Subsidiaries Adjustments Totals
- -------------------------------------------------------------------------------------------------------------------------
Net sales $ - $ 123,510 $ - $ 123,510
Cost of goods sold (exclusive of depreciation
and amortization) - 59,537 - 59,537
---------------------------------------------------------------
Gross profit - 63,973 - 63,973
Selling, general and administrative 4,553 40,224 - 44,777
Depreciation and amortization 335 2,449 - 2,784
---------------------------------------------------------------
Income from operations (4,888) 21,300 - 16,412
Interest expense (income), net (3,396) 12,475 - 9,079
Extinguishment of debt 4,686 - - 4,686
Equity in earnings of subsidiaries 8,825 - (8,825) -
---------------------------------------------------------------
Income before taxes 2,647 8,825 (8,825) 2,647
Provision for income taxes 1,125 - - 1,125
---------------------------------------------------------------
Net income $ 1,522 $ 8,825 $ (8,825) $ 1,522
===============================================================
STATEMENT OF CASH FLOWS
Three Months Ended March 31, 2002
(In thousands)
Cash flows provided by (used in) operating activities $ 3,631 $ 2,183 $ (8,825) $ (3,011)
Cash flows used in investing activities
Purchase of property, plant and equipment (116) (1,510) - (1,626)
Acquisitions and earnouts - (1,226) - (1,226)
Investment in subsidiaries (8,825) - 8,825 -
Proceeds from sale of certain assets - 1,492 - 1,492
---------------------------------------------------------------
Net cash provided by (used in) investing activities (8,941) (1,244) 8,825 (1,360)
---------------------------------------------------------------
Cash flows provided by (used in) financing activities
Repayments under revolving credit agreement (34,300) - - (34,300)
Proceeds from sale of senior notes 200,000 - - 200,000
Repayment and termination of bank loans (153,587) - - (153,587)
Scheduled repayment of long-term debt - (3,132) - (3,132)
Increase in financing costs (8,480) - - (8,480)
Proceeds from issuance of common stock 729 - - 729
---------------------------------------------------------------
Net cash provided by (used in) financing activities 4,362 (3,132) - 1,230
---------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (948) (2,193) - (3,141)
Cash and cash equivalents, beginning of period (212) 10,255 - 10,043
---------------------------------------------------------------
Cash and cash equivalents, end of period $(1,160) $ 8,062 $ - $ 6,902
===============================================================
19
ITEM 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
The following table sets forth for the periods indicated certain items of the
Company's Statements of Operations and their percentage of the Company's net
sales:
Three Months Ended
March 31,
---------------------------
2003 2002
---- ----
Net sales 100.0 % 100.0 %
Cost of goods sold 48.1 48.2
Gross profit 51.9 51.8
Selling, general and administrative 35.6 36.2
Depreciation and amortization 1.9 2.3
Income from operations 14.4 13.3
Interest expense, net 7.2 7.4
Extinguishment of debt - 3.8
Income before taxes 7.2 2.1
Provision for income taxes 2.9 0.9
Net income 4.3 1.2
Three Months Ended March 31, 2003 Compared to the Three Months Ended
March 31, 2002
Net Sales. Net sales for the quarter ended March 31, 2003 were $126.1 million,
an increase of $2.6 million, or 2.1%, versus net sales of $123.5 million for the
quarter ended March 31, 2002. The sales growth was primarily the result of a
1.0% increase in sales in the Company's O&P patient-care practices and a 22.2%
increase in outside sales of the distribution segment.
Gross Profit. Gross profit for the quarter ended March 31, 2003 was $65.4
million, an increase of approximately $1.4 million, or 2.3%, versus $64.0
million for the quarter ended March 31, 2002. Gross profit as a percentage of
net sales for the first quarter of 2003 increased slightly to 51.9% from 51.8%
for the first quarter of 2002. The improvement in gross profit, in both dollars
and as a percentage of net sales, was due to a reduction in material costs.
Selling, General and Administrative. Selling, general and administrative
expenses in the quarter ended March 31, 2003 remained relatively constant
compared to the same quarter in 2002. However, due to the increased net sales,
these expenses as a percentage of net sales dropped by 0.6 percentage points.
Depreciation and Amortization. Depreciation and amortization for the three
months ended March 31, 2003 was $2.5 million versus $2.8 million for the three
months ended March 31, 2002.
20
Income from Operations. Principally as a result of the above, income from
operations for the quarter ended March 31, 2003 was $18.2 million, an increase
of $1.8 million, or 11.0%, compared to the quarter ended March 31, 2002. Income
from operations, as a percentage of net sales, increased by 1.1 percentage
points to 14.4% of net sales in the first quarter of 2003 versus 13.3% for the
prior year's comparable period.
Interest Expense, Net. Interest expense in the first quarter of 2003 remained
constant compared to the same quarter in 2002.
Extinguishment of Debt. There were no charges for the extinguishment of debt in
the three months ended March 31, 2003. Extinguishment of debt was $4.7 million
in the three months ended March 31, 2002. In 2002, the extinguishment of debt
was reported as an extraordinary item, net of a tax benefit of $1.8 million. The
gross amount of this charge has been reclassified to a non-operating item as a
result of our adoption of Statement of Financial Accounting Standards 145,
Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement 13, and
Technical Corrections which is explained further under "New Accounting
Pronouncements" below.
Income Taxes. The provision for income taxes for the three months ended March
31, 2003 was $3.6 million compared to $1.1 million for the three months March
31, 2002. The change in the income tax provision was due to the Company's
increased profitability and increased income before taxes because there was no
benefit related to the extinguishment of debt in the three months ended March
31, 2003.
Net Income. As a result of the above, we recorded net income of $5.5 million for
the three months ended March 31, 2003, an improvement of $4.0 million over the
three months ended March 31, 2002.
Financial Condition, Liquidity, and Capital Resources
Our working capital at March 31, 2003 was $139.6 million compared to $126.7
million at December 31, 2002. While current assets decreased by $5.4 million,
current liabilities decreased by a larger amount, $18.3 million. The decline in
current liabilities was due principally to decreased obligations related to
accrued compensation costs. Our cash and cash equivalents amounted to $13.7
million at March 31, 2003, and $6.6 million at December 31, 2002. The ratio of
current assets to current liabilities increased to 3.9 to 1 at March 31, 2003,
compared to 2.9 to 1 at December 31, 2002. Available cash under our Revolving
Credit Facility decreased to $52.0 million at March 31, 2003 compared to $60.0
million at December 31, 2002 as the Company drew an additional $8 million, net
of expenses, to help fund the year-end practitioner bonus payout in March 2003.
Net cash provided by operating activities for the three months ended March 31,
2003 was $4.2 million, compared to net cash used in operating activities of $3.0
million in the three months ended March 31, 2002. The increase was primarily due
to the receipt of an $8.4 million income tax receivable which was outstanding at
December 31, 2002.
21
Net cash used in investing activities was $3.6 million for the three months
ended March 31, 2003, versus $1.4 million for the same period in the prior year.
The increase in net cash used was primarily due to capitalization of internal
use software and continuing leasehold improvements.
Net cash provided by financing activities was $6.5 million for the three months
ended March 31, 2003 compared to $1.2 million for the three months ended March
31, 2003. The increase in cash provided by financing activities was primarily
due to the net increase in borrowings under the Revolving Credit Facility of
$8.0 million.
On February 15, 2002, we received $200.0 million in proceeds from the sale of 10
3/8% Senior Notes due 2009 ("Senior Notes") in a private placement exempt from
registration under the Securities Act of 1933, as amended. The Senior Notes were
issued under an indenture, dated as of February 15, 2002, with Wilmington Trust
Company, as trustee. We also closed, concurrent with the sale of Senior Notes, a
new $75.0 million senior secured revolving line of credit ("New Revolving Credit
Facility"). The proceeds from the sale of Senior Notes and the New Revolving
Credit Facility were offset by (i) principal payments of $153.6 million to
retire our Tranche A & B Term Facilities, (ii) a net paydown of $38.3 million of
our prior revolving line of credit, and (iii) payment of $8.1 million in
financing costs related to the issuance of the Senior Notes and the
establishment of the New Revolving Credit Facility.
On April 30, 2003, the total available borrowings under the New Revolving Credit
Facility were increased from $75.0 million to $100.0 million and the
administrative agent was changed from BNP Paribas to GE Capital Corporation.
We believe that, based on current levels of operations and anticipated growth,
cash generated from operations, together with other available sources of
liquidity, including borrowings available under the New Revolving Credit
Facility, will be sufficient for the foreseeable future to fund anticipated
capital expenditures and make required payments of principal and interest on our
debt, including payments due on the Senior Notes and obligations under the New
Revolving Credit Facility. In addition, we continually evaluate potential
acquisitions and expect to fund such acquisitions from our available sources of
liquidity, as discussed above.
Market Risk
We are exposed to the market risk that is associated with changes in interest
rates. To manage that risk, in March 2002, we entered into interest rate swaps
to modify our exposure to interest rate movements and reduce borrowing costs. We
entered into $100.0 million fixed-to-floating interest rate swaps, consisting of
floating rate instruments benchmarked to LIBOR. We are exposed to potential
losses in the event of nonperformance by the counterparties to the swap
agreements.
22
New Accounting Pronouncements
In April 2002, the FASB issued Statement of Financial Accounting Standards 145,
Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement 13, and
Technical Corrections ("SFAS 145"). Under SFAS 145, gains and losses from the
early extinguishment of debt are no longer classified as extraordinary items,
unless they satisfy the criteria in Accounting Principles Board Opinion 30 ("APB
30") where extraordinary items are stated to be distinguishable by their unusual
nature and by the infrequency of their occurrence. Any gain or loss on
extinguishment of debt that was classified as an extraordinary item in prior
periods presented that does not meet the criteria in APB 30 for classification
as an extraordinary item has been reclassified. In addition, under SFAS 145,
certain lease modifications that have economic effects similar to sale-leaseback
transactions are to be accounted for in the same manner as sale-leaseback
transactions. SFAS 145 was effective for fiscal years beginning after May 15,
2002. SFAS 145 was adopted by us on January 1, 2003 and resulted in a
reclassification of existing extraordinary losses on the early extinguishment of
debt from an extraordinary item to a non-operating item.
In July 2002, the FASB issued Statement of Financial Accounting Standards 146,
Accounting for Costs Associated with Exit or Disposal Activities ("SFAS 146").
Under SFAS 146, costs associated with exit or disposal activities are to be
recognized when they are incurred rather than at the date of a commitment to an
exit or disposal plan. Such costs include lease termination costs and certain
employee severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. SFAS 146 is to be
applied prospectively to exit or disposal activities initiated after December
31, 2002. SFAS 146 has not had a material effect on our financial statements.
In December 2002, the FASB issued Statement of Financial Accounting Standards
148, Accounting for Stock-Based Compensation - Transition and Disclosure, an
amendment of SFAS Statement 123 ("SFAS 148"). SFAS 148 amends SFAS 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based compensation. We continue to use the intrinsic-value-based
method of accounting for stock-based employee compensation as prescribed by APB
Opinion 25. In addition, SFAS 148 amends the disclosure requirements of SFAS 123
to require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. We adopted the disclosure
provisions of SFAS 148 as of December 31, 2002. The adoption had no material
impact on our financial statements.
In November 2002, the FASB issued FASB Interpretation 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others ("FIN 45"). FIN 45 requires that, upon
issuance of a guarantee, a guarantor must recognize a liability for the fair
value of an obligation assumed under a guarantee. FIN 45 also requires
additional disclosures by a guarantor in its interim and annual financial
statements about the obligations associated with guarantees issued. The
recognition provisions of FIN 45 are effective for any guarantees that are
issued or modified after December 31, 2002. The disclosure
23
requirements are effective for our quarter ended March 31, 2003. The adoption
had no material impact on our financial statements.
Critical Accounting Estimates
Our analysis and discussion of our financial condition and results of operations
are based upon our Consolidated Financial Statements that have been prepared in
accordance with generally accepted accounting principles in the United States
("U.S. GAAP"). The preparation of financial statements in conformity with U.S.
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. U.S. GAAP provides the
framework from which to make these estimates, assumptions and disclosures. We
have chosen accounting policies within U.S. GAAP that management believes are
appropriate to accurately and fairly report our operating results and financial
position in a consistent manner. Management regularly assesses these policies in
light of current and forecasted economic conditions. Our accounting principles
are stated in Note B to the Consolidated Financial Statements as presented
elsewhere in this Form 10-Q and in our Annual Report on Form 10-K for the year
ended December 31, 2002. We believe the following accounting policies are
critical to understanding the results of operations and affect the more
significant judgments and estimates used in the preparation of the consolidated
financial statements.
o Revenue Recognition: Revenues on the sale of orthotic and prosthetic
devices and associated services to patients are recorded when the
device is accepted by the patient. Revenues on the sale of orthotic
and prosthetic devices to customers by our distribution segment are
recorded upon the shipment of products, in accordance with the terms
of the invoice. Revenue is recorded at its net realizable value taking
into consideration all governmental and contractual adjustments and
discounts. Deferred revenue represents both deposits made prior to the
final fitting and acceptance by the patient and unearned service
contract revenue. Subsequent to billing for our devices and services,
disallowed sales may result if there are problems with
pre-authorization or with other insurance coverage issues with third
party payers. If these problems occur, they are recognized as
reductions in sales. Other revenue may be uncollectible, even if
properly pre-authorized and billed. In the cases when valid revenue
cannot be collected, a bad debt expense is recognized. In addition to
the actual bad debt expense encountered during collection activities,
we estimate the amount of potential bad debt expense that may occur in
the future as we collect our receivables. This estimate is based upon
our historical experience as well as a detailed review of our
receivable balances.
o Inventories: Inventories, which consist principally of purchased parts
and work in process, are stated at the lower of cost or market using
the first-in, first-out (FIFO) method. We calculate cost of goods sold
in accordance with the gross profit method. We base 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 2001, a favorable adjustment was made in
24
the fourth quarter as a result of completing the physical inventory.
In 2002, virtually no adjustment was required in the fourth quarter as
we were more accurately estimating our cost of goods sold throughout
the year. Management adjusts our reserve for inventory obsolescence
whenever the facts and circumstances indicate that the carrying cost
of certain inventory items is in excess of its market price.
o Intangible Assets: Excess cost over net assets acquired ("Goodwill")
represents the excess of purchase price over the value assigned to net
identifiable assets of purchased businesses. We assess Goodwill for
impairment when events or circumstances indicate that the carrying
value may not be recoverable, or, at a minimum, annually as required
by SFAS 142. Any impairment would be recognized by a charge to
operating results and a reduction in the carrying value of the
intangible asset. We completed the annual impairment test as of
October 1, 2002, which did not result in the impairment of Goodwill.
This assessment included assumptions regarding estimated future cash
flows, discount rates and other factors.
Non-compete agreements are recorded based on the terms of the
agreements we have entered into and are amortized over their terms
ranging from 5 to 7 years using the straight-line method. Other
definite-lived intangible assets are recorded at cost and are
amortized over their estimated useful lives of up to 16 years using
the straight-line method. Whenever the facts and circumstances
indicate that the carrying amounts of these intangibles may not be
recoverable, management reviews and assesses the future cash flows
expected to be generated from the related intangible for possible
impairment. Any impairment would be recognized as a charge to
operating results and a reduction in the carrying value of the
intangible asset.
o Deferred Tax Assets (Liabilities): We account for certain income and
expense items differently for financial accounting purposes than for
income tax purposes. Deferred income taxes are provided in recognition
of these temporary differences. We recognize deferred tax assets, in
accordance with SFAS 109, if it is more likely than not the assets
will be realized in future years.
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 the Company in the United States District Court for
the District of Maryland on behalf of all purchasers of our common stock from
November 8, 1999 through and including January 6, 2000. The complaint also names
as defendants Ivan R. Sabel, the Company's Chairman of the Board and Chief
Executive Officer (and then President), and Richard A. Stein, the Company's
former Chief Financial Officer, Secretary and Treasurer (the "Class Action
Lawsuit").
The complaint alleges that during the above period of time, the defendants
violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934 by,
among other things, knowingly or recklessly
25
making material misrepresentations concerning the Company's financial results
for the quarter ended September 30, 1999, and the progress of the Company's
efforts to integrate the recently-acquired operations of NovaCare O&P. The
complaint further alleges that by making those material misrepresentations, the
defendants artificially inflated the price of the Company's common stock. The
plaintiff seeks to recover damages on behalf of all of the class members.
The Class Action Lawsuit has been dismissed by the District Court for failure to
comply with statutory requirements. On November 5, 2002, plaintiffs filed a
notice of appeal to the United States Court of Appeals for the Fourth Circuit.
The Company believes that the allegations have no merit and is vigorously
defending the Class Action Lawsuit. Additionally, the Company believes that it
is remote that any claims would result from this action and therefore, no
related liabilities have been recorded.
Other
Inflation has not had a significant effect on our operations, as increased costs
generally have been offset by increased prices of products and services sold. We
primarily provide customized devices and services 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 and operations. Actual results may
differ materially from projected or expected results due to changes in the
demand for our O&P products and services, uncertainties relating to the results
of operations or recently or newly acquired O&P patient-care practices, our
ability to successfully attract and retain qualified O&P practitioners, federal
laws governing the health-care industry, governmental policies affecting O&P
operations and other risks and uncertainties generally affecting the health-care
industry. Readers are cautioned not to put undue reliance on forward-looking
statements. We disclaim any intent or obligation to publicly update these
forward-looking statements, whether as a result of new information, future
events or otherwise.
26
ITEM 3: Quantitative and Qualitative Disclosures about Market Risk
We have existing obligations relating to our Senior Notes, Senior Subordinated
Notes, subordinated seller notes, and outstanding 7% Redeemable Convertible
Preferred Stock. We do not have cash flow exposure to changing interest rates on
these obligations because the interest and dividend rates of these securities
are fixed. However, as discussed below, we entered into two fixed-to-floating
interest rate swaps, in connection with the sale of our Senior Notes, whereby
the aggregate notional amount of the swaps equaled one-half of the principal
amount of the Senior Notes.
We have a $75 million Revolving Credit Facility, with an outstanding balance of
$23.0 million at March 31, 2003, as discussed in Note G to Hanger's Consolidated
Financial Statements ("Note G"). The rates at which interest accrues under the
entire outstanding balance are variable.
In addition, in the normal course of business, we are exposed to fluctuations in
interest rates. We address this risk by using interest rate swaps from time to
time. In March 2002, we entered into two fixed-to-floating interest rate swaps
with an aggregate notional amount of $100 million in connection with the sale of
our Senior Notes, as discussed in Note G. Variable rate debt and
fixed-to-floating interest rate swaps subject us to cash flow exposure resulting
from changing interest rates, as illustrated in the table below.
Presented below is an analysis as of March 31, 2003 of our financial instruments
that are sensitive to changes in interest rates. The table demonstrates the
change in cash flow related to the Senior Notes, as affected by the related
fixed-to-floating interest rate swaps, and the outstanding balance under the
Revolving Credit Facility, calculated for an instantaneous parallel shift in
interest rates, plus or minus 50 basis points ("BPS"), 100 BPS, and 150 BPS.
Annual Interest Expense No Change Annual Interest Expense
Given an Interest Rate in Interest Given an Interest Rate
Cash Flow Risk Decrease of X Basis Points Rates Increase of X Basis Points
- ---------------------------------- -------------------------------- -------------- -------------------------------
(In thousands) (150 BPS) (100 BPS) (50 BPS) Fair Value 50 BPS 100 BPS 150 BPS
------------ --------- -------- -------------- ---------- --------- ----------
Senior Notes (as affected by
related interest-rate swaps) $ 15,093 $ 15,593 $ 16,093 $ 16,593 $ 17,093 $ 17,593 $ 18,093
Revolving Credit Facility 637 752 867 982 1,097 1,212 1,327
------------------------------------------------------------------------------
$ 15,730 $ 16,345 $ 16,960 $ 17,575 $ 18,190 $ 18,805 $ 19,420
==============================================================================
27
ITEM 4: Controls and Procedures
Based upon an evaluation within the 90 days prior to the filing date of this
report, our Chief Executive Officer and Chief Financial Officer have concluded
that our disclosure controls and procedures are effective. There have been no
significant changes in our internal controls or in other factors that could
significantly affect our internal controls subsequent to the date of the
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
28
PART II OTHER INFORMATION
- --------------------------
ITEM 6: Exhibits and Reports on Form 8-K
Exhibits and Reports on Form 8-K
(a) Exhibits. The following exhibits are filed herewith:
Exhibit No. Document
99.1 Written Statement of the Chief Executive Officer Pursuant to
18 U.S.C.ss.1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.2 Written Statement of the Chief Financial Officer Pursuant to
18 U.S.C.ss.1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Forms 8-K. No Current Report on Form 8-K was filed during the
quarter ended March 31, 2003.
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HANGER ORTHOPEDIC GROUP, INC.
Dated: May 13, 2003 /s/ Ivan R. Sabel
------------------------------------
Ivan R. Sabel, CPO
Chairman and Chief Executive Officer
(Principal Executive Officer)
Dated: May 13, 2003 /s/ George E. McHenry
------------------------------------
George E. McHenry
Chief Financial Officer
(Principal Financial Officer)
Dated: May 13, 2003 /s/ Glenn M. Lohrmann
------------------------------------
Glenn M. Lohrmann
Controller
(Chief Accounting Officer)
30
CERTIFICATIONS
I, Ivan R. Sabel, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Hanger Orthopedic
Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 13, 2003 /s/ Ivan R. Sabel
------------------------------------
Ivan R. Sabel, CPO
Chairman and Chief Executive Officer
31
I, George E. McHenry, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Hanger Orthopedic
Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 13, 2003 /s/ George E. McHenry
------------------------------------
George E. McHenry
Chief Financial Officer
32