SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1998
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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 ___________________
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.)
7700 Old Georgetown Road, Bethesda, MD 20814
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(Address of principal executive offices) (Zip Code)
Registrant's phone 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 whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares
outstanding of each of the issuer's classes of common stock, as of August 14,
1998; 18,178,751 shares of common stock, $.01 par value per share.
<PAGE>
HANGER ORTHOPEDIC GROUP, INC.
INDEX
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - September 30,1998
(unaudited) and December 31, 1997 1
Consolidated Statements of Income for the three
months ended September 30, 1998 and 1997 (unaudited) 3
Consolidated Statements of Income for the nine
months ended September 30, 1998 and 1997 (unaudited) 4
Consolidated Statements of Cash Flows for the nine
months ended September 30, 1998 and 1997 (unaudited) 5
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
</TABLE>
<PAGE>
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
-------------- --------------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 9,439,692 $ 6,557,409
Accounts receivable less allowances for
doubtful accounts of $8,030,000 and $4,871,000
in 1998 and 1997, respectively 35,725,044 31,145,327
Inventories 18,683,711 17,445,476
Prepaid expenses and other assets 4,717,819 4,260,656
Deferred income taxes 2,127,185 2,127,185
-------------- --------------
Total current assets 70,693,451 61,536,053
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PROPERTY, PLANT AND EQUIPMENT
Land 4,267,045 4,269,045
Buildings 8,420,692 8,326,732
Machinery and equipment 12,379,676 7,591,821
Furniture and fixtures 2,898,825 2,378,808
Leasehold improvements 4,079,137 3,142,244
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32,045,375 25,708,650
Less accumulated depreciation and amortization 9,539,484 7,538,385
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22,505,891 18,170,265
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INTANGIBLE ASSETS
Excess of cost over net assets acquired 111,188,711 81,150,328
Non-compete agreements 2,604,417 2,236,979
Other intangible assets 3,568,230 3,221,912
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117,361,358 86,609,219
Less accumulated amortization 11,449,566 9,101,531
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105,911,792 77,507,688
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OTHER ASSETS
Other 867,562 768,604
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TOTAL ASSETS $ 199,978,696 $ 157,982,610
============== ==============
</TABLE>
The accompany notes are an integral part of the consolidated financial
statements.
1
<PAGE>
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
-------------- --------------
(unaudited)
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt $ 4,484,243 $ 5,747,865
Accounts payable 5,197,459 3,827,338
Accrued expenses 5,413,039 3,597,104
Customer deposits 1,103,294 1,145,001
Accrued wages and payroll taxes 8,639,105 8,037,805
Deferred revenue 273,024 150,418
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Total current liabilities 25,110,164 22,505,531
-------------- --------------
Long-term debt 11,762,013 23,237,321
Deferred income taxes 3,405,833 3,405,833
Other liabilities 2,257,567 2,210,445
Mandatorily redeemable preferred stock, class C,
liquidation preference of $500 per share 324,881 303,753
Mandatorily redeemable preferred stock, class F,
liquidation preference of $500 per share
SHAREHOLDERS' EQUITY
Common stock, $.01 par value; 25,000,000 shares
authorized, 18,459,989 and 15,670,100 shares
issued, and 18,326,494 and 15,536,605 shares
outstanding in 1998 and 1997 184,601 156,702
Additional paid-in capital 143,922,864 102,585,837
Retained earnings 13,666,335 4,232,750
-------------- --------------
157,773,800 106,975,289
Treasury stock - (133,495 shares) (655,562) (655,562)
-------------- --------------
157,118,238 106,319,727
-------------- --------------
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $ 199,978,696 $ 157,982,610
============== ==============
</TABLE>
The accompany notes are an integral part of the consolidated financial
statements.
2
<PAGE>
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED September 30, 1998 and 1997
(unaudited)
<TABLE>
<CAPTION>
1998 1997
-------------- --------------
<S> <C> <C>
Net Sales $ 48,776,505 $ 38,839,333
Cost of products and services sold 23,977,787 19,779,856
-------------- --------------
Gross profit 24,798,718 19,059,477
Selling, general & administrative 15,915,819 12,898,204
Depreciation and amortization 865,445 716,244
Amortization of excess cost over net assets acquired 656,545 460,882
-------------- --------------
Income from operations 7,360,909 4,984,147
Other expense:
Interest expense, net (386,833) (1,079,184)
Other 8,878 (44,710)
-------------- --------------
Income before income taxes 6,982,954 3,860,253
Provision for income taxes 2,863,000 1,620,836
-------------- --------------
Net income before extraordinary item 4,119,954 2,239,417
Extraordinary loss on early extinguishment of debt
(net of tax benefit of $1,950,700) (2,693,791)
-------------- --------------
Net income (loss) $ 4,119,954 $ (454,374)
============== ==============
Basic Per Common Share Data
Net income before extraordinary item $ .24 $ .17
Extraordinary item (.20)
-------------- --------------
Net income $ .24 $ (.03)
============== ==============
Shares used to compute basic per common
share amounts 17,291,768 12,871,560
============== ==============
Diluted Per Common Share Data
Net income before extraordinary item $ .22 $ .15
Extraordinary item (.18)
-------------- --------------
Net income $ .22 $ (.03)
============== ==============
Shares used to compute diluted per common share
Amounts 19,039,164 14,426,302
============== ==============
</TABLE>
The accompany notes are an integral part of the consolidated financial
statements.
3
<PAGE>
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED September 30, 1998 and 1997
(unaudited)
<TABLE>
<CAPTION>
1998 1997
-------------- --------------
<S> <C> <C>
Net Sales $ 136,426,413 $ 106,433,592
Cost of products and services sold 68,541,960 54,331,907
-------------- --------------
Gross profit 67,884,453 52,101,685
Selling, general & administrative 46,099,269 35,862,411
Depreciation and amortization 2,351,227 2,210,508
Amortization of excess cost over net assets acquired 1,783,932 1,321,714
-------------- --------------
Income from operations 17,650,025 12,707,052
Other income expense:
Interest expense, net (1,700,664) (4,455,955)
Other income (expense) 39,224 (131,695)
-------------- --------------
Income before income taxes 15,988,585 8,119,402
Provision for income taxes 6,555,000 3,410,136
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Net income before extraordinary item 9,433,585 4,709,266
Extraordinary loss on early extinguishment of debt
(net of tax benefit of $1,950,700) (2,693,791)
-------------- --------------
Net income $ 9,433,585 $ 2,015,475
============== ==============
Basic Per Common Share Data
Net income before extraordinary item $ .58 $ .45
Extraordinary item (.26)
-------------- --------------
Net income $ .58 $ .19
============== ==============
Shares used to compute basic per common
Share amounts 16,197,010 10,562,973
============== ==============
Diluted Per Common Share Data
Net income before extraordinary item $ .53 $ .40
Extraordinary item (.23)
-------------- --------------
Net income $ .53 $ .17
============== ==============
Shares used to compute diluted per common
Share amounts 17,878,220 11,806,607
============== ==============
</TABLE>
The accompany notes are an integral part of the consolidated financial
statements.
4
<PAGE>
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED September 30, 1998 and 1997
(unaudited)
<TABLE>
<CAPTION>
1998 1997
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 9,433,585 $ 2,015,475
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for bad debt 5,292,635 3,958,988
Depreciation and amortization 2,351,227 2,210,508
Amortization of excess cost over net
assets acquired 1,783,932 1,321,714
Amortization of debt discount 152,065
Extraordinary loss on the early extinguishment of debt 4,644,491
Changes in assets and liabilities, net
of effect from acquired companies:
Accounts receivable (6,157,066) (8,552,527)
Inventory 546,095 194,269
Prepaid and other assets (4,270) (402,809)
Other assets (13,588) 101,329
Accounts payable (194,924) (1,348,312)
Accrued expenses 1,088,555 (1,594,727)
Accrued wages and payroll taxes (117,847) (2,509,158)
Customer deposits (42,129) 444,922
Deferred revenue (75,284) (115,985)
Other liabilities 47,122 201,984
-------------- --------------
Total adjustments 4,504,458 (1,293,248)
-------------- --------------
Net cash provided by operating activities 13,938,043 722,227
-------------- --------------
Cash flows from investing activities:
Purchase of fixed assets, net (2,023,990) (1,769,833)
Acquisitions, net of cash (28,245,808) (8,649,183)
Purchase of patents (14,053) (88,779)
Purchase of non-compete agreements (367,438) (138,151)
-------------- --------------
Net cash used in investing activities (30,651,289) (10,645,946)
-------------- --------------
</TABLE>
Continued
The accompany notes are an integral part of the consolidated financial
statements.
5
<PAGE>
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED September 30, 1998 and 1997
(unaudited)
<TABLE>
<CAPTION>
1998 1997
-------------- --------------
<S> <C> <C>
Cash flows from financing activities:
Net borrowings under revolving credit facility $ --- $ ---
Proceeds from sale of common stock 39,186,054 60,202,157
Proceeds from long-term debt 6,000,000 8,256,000
Repayment of long-term debt (25,590,525) (58,627,500)
-------------- --------------
Net cash provided by financing activities 19,595,529 9,830,657
-------------- --------------
Net change in cash and cash equivalents for the period 2,882,283 (93,062)
Cash and cash equivalents at beginning of period 6,557,409 6,572,402
-------------- --------------
Cash and cash equivalents at end of period $ 9,439,692 $ 6,479,340
============== ==============
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 1,526,460 $ 4,270,921
============== ==============
Taxes $ 5,948,700 $ 2,306,000
============== ==============
Non-cash financing and investing activities:
Issuance of common stock in connection with
acquisition $ 2,200,000 $ 500,000
============== ==============
Issuance of notes in connection with acquisitions $ 6,773,457 $ 2,864,200
============== ==============
Dividends declared preferred stock $ 21,128 $ 19,319
============== ==============
</TABLE>
The accompany notes are an integral part of the consolidated financial
statements.
6
<PAGE>
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 for
complete financial statements. In the opinion of management, all adjustments,
consisting of a normal recurring nature, considered necessary for a fair
presentation have been included.
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, 1997, filed by the Company with the Securities and Exchange
Commission.
NOTE B - NEW ACCOUNTING STANDARDS
During the fourth quarter of 1997, the Company adopted the provisions of
Statement of Financial Accounting Standards (SFAS) 128 and, as required, has
restated all prior period per common share data.
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. Reclassification of financial statements for earlier
periods provided for comparative purposes is required. The adoption of SFAS
130 had no effect on the Company's consolidated financial statements.
The Company will adopt the provisions of SFAS 131, "Disclosures about
Segments of an Enterprise and Related Information" effective with the
financial statements for the year ended December 31, 1998. SFAS 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. Financial statement disclosures for
prior periods are required to be restated. The Company is in the process of
evaluating the disclosure requirements. The adoption of SFAS 131 affects
disclosure only and will not affect reported earnings, cash flows or financial
position.
In June 1998, the Financial Accounting Standard Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities", which is
effective for fiscal years beginning after June 15, 1999. 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 will adopt SFAS 133 by the first quarter of 2000. Due to the Company's
7
<PAGE>
limited use of derivative instruments, SFAS 133 is not expected to have a
material effect on the financial position or results of operations of the
Company.
NOTE C -- INVENTORY
Inventories at September 30, 1998 and December 31, 1997 were comprised
of the following:
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
------------------ -----------------
(unaudited)
<S> <C> <C>
Raw materials $ 8,457,045 $ 7,685,134
Work-in-process 1,705,713 1,437,946
Finished goods 8,520,953 8,322,396
-------------- --------------
$ 18,683,711 $ 17,445,476
============== ==============
</TABLE>
NOTE D - ACQUISITIONS
During the first nine months of 1998, the Company acquired twelve
orthotic and prosthetic companies and one prosthetic component manufacturing
company. The aggregate purchase price, excluding potential earn-out
provisions, was $35,990,000, comprised of $27,017,000 in cash, $6,773,000 in
promissory notes and 132,331 shares of common stock of the Company valued at
$2,200,000. The notes are payable over three to five years with interest rates
ranging from 6% to 7%. The cash portion of the purchase price for these
acquisitions was borrowed under the Company's revolving and acquisition loan
commitments and cash. The excess cost of the above acquisitions over the
recorded amount of net assets acquired amounted to approximately $28,522,000.
During the first nine months of 1998, the Company paid approximately
$531,000 to the former owners of ACOR Orthopaedic, Inc. - Retail Division,
pursuant to earnout provisions contained in the 1997 acquisition agreement. In
addition, the Company paid approximately $740,000 to the former owners of
Seattle Limb Systems, Inc. and $297,000 to the former owners of Fort Walton
Orthopedic Inc. and Mobile Limb and Brace, Inc., pursuant to working capital
provisions contained in the respective acquisition agreement. 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
$1,568,000.
8
<PAGE>
NOTE E - NET INCOME PER COMMON SHARE
The following sets forth the calculation of the basic and diluted income
per common share amounts for the three month period ended September 30, 1998
and 1997 and the nine month period ended September 30, 1998 and 1997.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
----------------------------- ----------------------------
1998 1997 1998 1997
------------- ------------- ------------- ------------
<S> <C> <C> <C> <C>
Net income (loss) $ 4,119,954 $ (454,374) $ 9,433,585 $ 2,015,475
Less preferred stock dividends declared (7,199) (6,584) (21,128) (19,319)
------------- ------------- ------------- ------------
Income available to common stockholders
used to compute basic per common
share amounts $ 4,112,755 $ (460,958) $ 9,412,457 $ 1,996,156
============= ============= ============= ============
Add back interest expense on convertible
note payable, net of tax 14,824 0 29,648 0
Income available to common stockholders
plus assumed conversions used to com-
pute diluted per common share amounts $ 4,127,579 $ (460,958) $ 9,442,105 $ 1,996,156
============= ============= ============= ============
Average shares of common stock
outstanding used to compute basic per
common share amounts 17,291,768 12,871,560 16,197,010 10,562,973
Effect of convertible note payable 115,717 77,992
Effect of dilutive options 804,799 830,673 810,864 554,345
Effect of dilutive warrants 826,880 724,069 792,354 689,289
Shares used to compute dilutive per
------------- ------------- ------------- ------------
common share amounts 19,039,164 14,426,302 17,878,220 11,806,607
============= ============= ============= ============
Basic income per common share $ .24 $ (.03) $ .58 $ .19
Diluted income per common share $ .22 $ (.03) $ .53 $ .17
</TABLE>
Options to purchase 28,179 shares of common stock were outstanding at
September 30, 1998 but were not included in the computation of diluted income
per common share for the nine months ended September 30, 1998 because the
options' exercise price was greater than the average market price of the
common shares.
Options to purchase 1,348 shares of common stock were outstanding at
September 30, 1998 but were not included in the computation of basic income
per common share for the nine months ended September 30, 1998 because the
options' exercise price was greater than the average market price of the
common shares.
9
<PAGE>
NOTE F --- EQUITY OFFERING
In an underwritten public offering that was consummated on August 4,
1998, 3,300,000 shares of common stock of the Company were sold at $17.00 per
share. Of that amount, 2,400,000 shares were sold by the Company and 900,000
shares were sold by certain stockholders 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 senior indebtedness.
10
<PAGE>
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 Income and their percentage of the Company's
net sales:
<TABLE>
<CAPTION>
Nine Months Three Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products and services sold 50.2 51.0 49.2 50.9
Gross profit 49.8 49.0 50.8 49.1
Selling, general & administrative
expenses 33.8 33.7 32.6 33.2
Depreciation and amortization 1.7 2.1 1.8 1.8
Amortization of excess cost over net
assets acquired 1.3 1.2 1.3 1.2
Income from operations 12.9 11.9 15.1 12.8
Interest expense 1.2 4.2 .8 2.8
Provision for income taxes 4.8 3.2 5.9 4.2
Net income before extraordinary item 4.4 5.8
Loss from early extinguishment of debt 2.5 6.9
Net income 6.9 1.9 8.4 1.2
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 1997
NET SALES
Net sales for the quarter ended September 30, 1998, were
approximately $48,777,000, an increase of approximately $9,937,000, or 25.6%,
over net sales of approximately $38,839,000 for the quarter ended September
30, 1997. The majority of the increase was attributable to acquisitions
consummated subsequent to September 30, 1997. In addition, contributing to the
increase in net sales was a 10.0% increase in sales by those Hanger
patient-care centers operating throughout both quarters.
GROSS PROFIT
Gross profit in the quarter ended September 30, 1998 was
approximately $24,799,000, an increase of approximately $5,739,000, or 30.1%,
over gross profit of approximately $19,059,000 for the quarter ended September
30, 1997. The increase was primarily attributable to the increase in net
sales. Gross profit as a percentage of net sales increased to 50.8% in the
third quarter of 1998 from 49.1% in the third quarter of 1997.
11
<PAGE>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses in the quarter ended
September 30, 1998 increased by approximately $3,018,000, or 23.4%, compared
to the quarter ended September 30, 1997. Selling, general and administrative
expenses as a percentage of net sales decreased to 32.6% compared to 33.2% for
same period in 1997.
INCOME FROM OPERATIONS
Principally as a result of the above, income from operations in
the quarter ended September 30, 1998 was approximately $7,361,000, an increase
of $2,377,000, or 47.7%, over the prior year's comparable quarter. Income from
operations as a percentage of net sales increased to 15.1% in the second
quarter of 1998 from 12.8% for the prior year's comparable period.
INTEREST EXPENSE
Net interest expense in the third quarter of 1998 was
approximately $387,000, a decrease of approximately $692,000, or 64.2%, from
approximately $1,079,000 incurred in the third quarter of 1997. Interest
expense as a percentage of net sales decreased to .8% from 2.8% for the same
period a year ago. The decrease in interest expense was primarily attributable
to the repayment of $24.7 million of indebtedness during August of 1998 from
the proceeds of an underwritten public offering consummated in that month in
which the Company sold 2,400,000 shares of common stock at $17.00 per share.
INCOME TAXES
The Company's effective tax rate was 41% in the third quarter of
1998 versus 42.0% in 1997. The provision for income taxes in the third quarter
of 1998 was approximately $2,863,000 compared to approximately $1,621,000 for
the third quarter of 1997.
EXTRAORDINARY ITEM
An extraordinary item of approximately $2.7 million in the third
quarter of 1997 (net of a tax benefit of approximately $2.0 million),
represents entirely a non-cash write-off of debt issue costs and debt discount
as a result of extinguishing approximately $58.6 million of bank debt from the
net proceeds of a public equity offering during that quarter.
NET INCOME
As a result of the above, the Company recorded net income of
$4,120,000, or $.22 per dilutive common share, in the quarter ended September
30, 1998, compared to net loss of $454,000, or $.03 per dilutive common share,
in the quarter ended September 30, 1997.
12
<PAGE>
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997
NET SALES
Net sales for the nine months ended September 30, 1998 were
approximately $136,426,000, an increase of approximately $29,993,000, or
28.2%, over net sales of approximately $106,434,000 for the nine months ended
September 30, 1997. The majority of the increase was attributable to
acquisitions consummated subsequent to September 30, 1997. In addition,
contributing to the increase in net sales was a 11.0% increase in sales by
those Hanger patient-care centers operating throughout both nine-month
periods.
GROSS PROFIT
Gross profit for the nine months ended September 30, 1998 was
approximately $67,884,000, an increase of approximately $15,783,000, or 30.3%,
over gross profit of approximately $52,102,000 for the nine months ended
September 30, 1997. The increase was primarily attributable to the increase in
net sales. Gross profit as a percent of net sales increased from 49.0% in the
nine months ended September 30, 1997 to 49.8% in the nine months ended
September 30, 1998.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses in the nine months
ended September 30, 1998 increased by approximately $10,237,000, or 28.5%,
compared to the nine months ended September 30, 1997. Selling, general and
administrative expenses as a percentage of net sales increased to 33.8% from
33.7% for the same period in 1997.
INCOME FROM OPERATIONS
Principally as a result of the above, income from operations in
the nine months ended September 30, 1998 was approximately $17,650,000, an
increase of approximately $4,943,000, or 38.9%, over the prior year's
comparable period. Income from operations as a percentage of net sales
increased to 12.9% in the nine months ended September 30, 1998 from 11.9% in
the nine months ended September 30, 1997.
INTEREST EXPENSE
Net interest expense for the first nine months of 1998 was
approximately $1,701,000, a decrease of approximately $2,755,000, or 61.8%,
from approximately $4,456,000 incurred in the first nine months of 1997.
Interest expense as a percentage of net sales decreased to 1.2% from 4.2% for
the same period one year ago. The decrease in interest expense was primarily
13
<PAGE>
attributable to the repayment of $24.7 million of indebtedness during August
of 1998 from the proceeds of an underwritten public offering consummated in
that month in which the Company sold 2,400,000 shares of common stock at
$17.00 per share.
INCOME TAXES
The Company's effective tax rate was 41.0% in the first nine
months of 1998 versus 42.0% in 1997. The provision for income taxes for the
nine months ended September 30, 1998 was approximately $6,555,000 compared to
approximately $3,410,000 for the nine months ended September 30, 1997.
EXTRAORDINARY ITEM
An extraordinary item of approximately $2.7 million in the third
quarter of 1997 (net of a tax benefit of approximately $2.0 million),
represents entirely a non-cash write-off of debt issue costs and debt discount
as a result of extinguishing approximately $58.6 million of bank debt from the
net proceeds of a public equity offering during that quarter.
NET INCOME
As a result of the above, the Company recorded net income of
approximately $9,434,000, or $.53 per dilutive common share, in the first nine
months of 1998, compared to net income of approximately $2,015,000, or $.17
per dilutive common share, in the first nine months of 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company's consolidated working capital at September 30, 1998
was approximately $45,583,000 and cash and cash equivalents available were
approximately $9,440,000. The Company's cash resources were satisfactory to
meet its obligations for the quarter ended September 30, 1998.
The Company has a credit agreement (the "Credit Agreement") with a
syndicate of banks, (collectively, the "Banks") that provides for (i) an
A-Term Loan of up to $29,000,000 (the "A-Term Loan"); (ii) a B-Term Loan of up
to $28,000,000 (the "B-Term Loan"); (iii) an acquisition loan of up to
$25,000,000 (the "Acquisition Loan"); and (iv) a revolving loan of up to
$8,000,000 (the "Revolving Loan").
The Company's total long-term debt at September 30, 1998 was
approximately $16,246,000, consisting of seller notes and other indebtedness.
No borrowings were outstanding under the Credit Agreement on September 30,
1998.
14
<PAGE>
The Credit Agreement 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.
The A-Term Loan, the Acquisition Loan and the Revolving Loan bear
base interest at the Company's option of either LIBOR plus 2.50% or the Bank's
prime rate plus 1.50%. The base interest rate is then reduced by .25% to 1.25%
depending upon the ratio of the Company's total indebtedness to annual
earnings before interest, taxes, depreciation and amortization. The A-Term
Loan was repaid with the proceeds of the public offering on August 4, 1998.
The B-Term Loan bore base interest at the Company's option of
either LIBOR plus 2.75% or the Bank's prime rate plus 1.75%. The base interest
rate were then reduced by .25% to 1.25% depending upon the ratio of the
Company's total indebtedness to annual earnings before interest, taxes,
depreciation and amortization. The B-Term Loan was repaid with the proceeds of
the public offering consummated on August 4, 1998.
All or any portion of outstanding loans under the Credit Agreement
may be repaid at any time and commitments may be terminated in whole or in
part at the option of the Company 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.
During the first nine months of 1998, the Company acquired twelve
orthotic and prosthetic companies and one prosthetic component manufacturing
company. The aggregate purchase price excluding potential earn-out provisions
was $35,990,000, comprised of $27,017,000 in cash, $6,773,000 in promissory
notes and 132,331 shares of common stock of the Company valued at $2,200,000.
The cash portion of the purchase price of these acquisitions was borrowed
under the Company's Revolving Loan and Acquisition Loan and cash. The
Revolving Loan and Acquisition Loan were repaid with the proceeds of the
public offering consummated on August 4, 1998.
The Company plans to finance future acquisitions through
internally generated funds or borrowings under the Acquisition Loan, the
issuance of notes or shares of Common Stock of the Company, or through a
combination thereof.
The Company is actively engaged in ongoing discussions with
prospective acquisition candidates. The Company plans to continue to expand
its operations aggressively through acquisitions.
In an underwritten public offering consummated on August 4, 1998,
3,300,000 shares of common stock of the Company were sold at $17.00 per share.
Of that amount, 2,400,000 shares were sold by the Company and 900,000 shares
were sold by certain stockholders of the Company. Of the approximately $37.8
million of net proceeds of the offering, a total of $24.7 million was used to
15
<PAGE>
repay the outstanding amounts of the A-Term Loan and B-Term Loan, Acquisition
Loan and Revolving Loan. The underwriters did not exercise the over allotment
option to purchase up to 495,000 additional shares of common stock.
OTHER
Inflation has not had a significant effect on the Company's
operations, as increased costs to the Company generally have been offset by
increased prices of products and services sold.
The Company will adopt the provisions of SFAS 131, "Disclosures
about Segments of an Enterprise and Related Information" effective with the
financial statements for the year ended December 31, 1998. SFAS 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. Financial statement disclosures for
prior periods are required to be restated. The Company is in the process of
evaluating the disclosure requirements. The adoption of SFAS 131 affects
disclosure only and will not affect reported earnings, cash flows or financial
position.
In June 1998, the Financial Accounting Standard Board issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities", which
is effective for fiscal years beginning after June 15, 1999. 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 will adopt SFAS 133 by the first quarter of 2000. Due to the Company's
limited use of derivative instruments, SFAS 133 is not expected to have a
material effect on the financial position or results of operations of the
Company.
The Company primarily provides services and customized devices
throughout the United States and is reimbursed, in large part, by the
patients' third-party insurers or governmentally funded health insurance
programs. The ability of the Company's debtors to meet their obligations is
principally dependent upon the financial stability of the insurers of the
Company's patients and future legislation and regulatory actions.
The Company currently is upgrading its patient care, manufacturing
and headquarters information systems. Included in the upgrading is a program
to ensure that all significant computer systems are substantially Year 2000
compliant by the year ending December 31, 1999. The program is divided into
three major components: (1) identification of all information technology
systems ("IT Systems") and non-information technology systems ("Non-IT
16
<PAGE>
Systems") that are not Year 2000 compliant: (2) repair or replacement of the
identified non-compliant systems; and (3) testing of the repaired or replaced
systems. The Company has no "in house" developed or proprietary IT Systems.
The Company uses commercially developed software, the majority of which is
constantly upgraded through existing maintenance contracts. Parts (1) and (2)
of the Year 2000 program are currently underway. Part (1), identification,
should be completed by the end of the current calendar year. Review of
accounting and financial reporting systems is nearly finished and the Company
is continuing to review Non-IT Systems that have embedded microprocessors in
various types of equipment. Part (2), repairing and replacing, currently
continues, primarily under maintenance contracts with the Company's software
vendors. While most of the major systems are 2000 compliant, the software
vendors have targeted December 1998 as a completion date. Part (3), testing,
is scheduled to start in the first quarter of 1999 and to finish at the end of
that quarter.
The Company has been contacting key suppliers and business
partners about the Year 2000 issue. While no assurance can be given that key
suppliers and business partners will remedy their own Year 2000 issues, the
Company, to date, has not identified any material impact on its ability to
continue normal business operations with suppliers or other third parties who
fail to address the issue.
The Company presently estimates that projected costs to implement
the Company's Year 2000 program, primarily for hardware, will approximate $1.3
million. The projected total costs for the upgrading of the Company's
information systems, including the Year 2000 program, are estimated to range
from $2.25 million to $2.75 million.
The Company will continue to monitor and evaluate the impact of
the Year 2000 issue on its operations. Until the Company is into the final
testing part of its program, the risks from potential Year 2000 failures
cannot be fully assessed. Due to this situation, the Company cannot now begin
final contingency plans. These plans will be developed as potential Year 2000
failures are identified in the final testing stages.
This report contains forward-looking statements setting forth the
Company's beliefs or expectations relating to future revenues. Actual results
may differ materially from projected or expected results due to changes in the
demand for the Company's O&P services and products, uncertainties relating to
the results of operations or recently acquired and newly acquired O&P patient
care practices and prosthetic component manufacturing, the Company's ability
to attract and retain qualified O&P practitioners, governmental policies
affecting O&P operations and other risks and uncertainties affecting the
health-care industry generally. Readers are cautioned not to put undue
reliance on forward-looking statements. The Company disclaims any intent or
obligation to up-date publicly these forward-looking statements, whether as a
result of new information, future events or otherwise.
PART II. OTHER INFORMATION
17
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit 27 Financial Data Schedule
(b) REPORTS ON FORM 8-K
None
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HANGER ORTHOPEDIC GROUP, INC.
Date: November 6, 1998 /s/IVAN R. SABEL
------------------
Ivan R. Sabel, CPO
Chief Executive Officer
Date: November 6, 1998 /s/RICHARD A. STEIN
-------------------
Richard A. Stein
Vice President - Finance
Principal Financial and
Accounting Officer
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