SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the fiscal year ended DECEMBER 31, 1998
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
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $.01 per share
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(Title of Class)
Securities registered pursuant to section 12(g) of the Act: None.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days: Yes [X] No [ ]
The aggregate market value of the registrant's Common Stock, par value
$.01 per share, held as of March 17, 1999 by non-affiliates of the registrant
was $228,355,686 based on the $13.00 closing sale price of the Common Stock on
the New York Stock Exchange on such date.
As of March 17, 1999, the registrant had 18,825,712 shares of its Common
Stock issued and outstanding.
Indicate by check mark if disclosure of delinquent filers pursuant to
item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.[X]
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DOCUMENTS INCORPORATED BY REFERENCE
The information called for by Part III of the Form 10-K is incorporated
by reference from the registrant's definitive proxy statement or amendment
hereto which will be filed not later than 120 days after the end of the fiscal
year covered by this report.
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ITEM 1. BUSINESS.
OVERVIEW
Hanger Orthopedic Group, Inc. is a professional practice management
company focused on the orthotic and prosthetic ("O&P") of the orthopedic
rehabilitation industry. The Company acquires and operates the practices of
orthotists and prosthetists, medical professionals that design, fabricate, fit
and supervise the use of external musculoskeletal support devices and
artificial limbs. The Company has acquired over 75 O&P businesses since 1986
and at December 31, 1998, employed 321 certified O&P practitioners and
operated 256 O&P centers in 30 states and the District of Columbia. The
Company also has developed OPNET, a national preferred provider network of O&P
service professionals. At December 31, 1998, OPNET had contractual
relationships with 390 patient-care centers (256 of which are owned and
operated by the Company) serving 353 managed care plans. In addition to its
practice management and patient-care services, the Company manufactures
custom-made and prefabricated O&P devices and is the largest distributor of
O&P components and finished O&P patient-care products in the United States.
The combination of practice management and patient-care services, OPNET and
manufacturing and distribution operations positions the Company as a
fully-integrated provider of O&P services.
INDUSTRY BACKGROUND
Orthotics is the design, fabrication, fitting and supervised use of
custom-made braces and other devices that provide external support to treat
musculoskeletal disorders. Musculoskeletal disorders are ailments of the back,
extremities or joints caused by traumatic injuries, chronic conditions,
diseases, congenital disorders or injuries resulting from sports or other
activities. Prosthetics is the design, fabrication and fitting of custom-made
artificial limbs for patients who have lost limbs as a result of traumatic
injuries, vascular diseases, diabetes, cancer or congenital disorders.
Care of O&P patients is part of a continuum of rehabilitation services
from diagnosis to treatment and prevention of future injury. This continuum
involves the integration of several medical disciplines that begins with the
attending physician's diagnosis. Once a course of treatment is determined, the
physician, generally an orthopedic surgeon, vascular surgeon or psysiatrist,
refers a patient to an O&P patient-care service provider for treatment. An O&P
practitioner then consults with both the referring physician and the patient
to formulate the prescription for and design of, an orthotic or prosthetic
device to meet the patient's needs.
The Company estimates that the O&P patient-care services industry in the
United States represented approximately $2.3 billion in sales in 1997. Key
trends expected to increase demand for orthopedic rehabilitation services
include the following:
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GROWING ELDERLY POPULATION. The growth rate of the over-65 age
group is nearly triple that of the under-65 age group. With broader
medical insurance coverage, increasing disposable income, longer life
expectancy, greater mobility and improved technology and devices, the
elderly are expected to seek orthopedic rehabilitation services more
often.
COST-EFFECTIVE REDUCTION IN HOSPITALIZATION. As public and private
payors encourage reduced hospital admissions and reduced length of stay,
out-patient rehabilitation is in greater demand. O&P services and
devices have enabled patients to become ambulatory more quickly after
receiving medical treatment in the hospital. The Company believes that
significant cost savings can be achieved through the early use of O&P
services. The provision of O&P services in many cases reduces the need
for more expensive treatments, thus representing a cost savings to the
third-party payor.
GROWING PHYSICAL HEALTH CONSCIOUSNESS. There is a growing emphasis
on physical fitness, leisure sports and conditioning, such as running
and aerobics, which has led to increased injuries requiring orthopedic
rehabilitative services and products. In addition, as the current
middle-age population ages, it brings its more active life-style and
accompanying emphasis on physical fitness to the over-65 age group.
These trends are evidenced by the increasing demand for new devices
which provide support for injuries, prevent further or new injuries or
enhance physical performance.
ADVANCING TECHNOLOGY. The range and effectiveness of treatment
options have increased in connection with the technological
sophistication of O&P devices. Advances in design technology and
lighter, stronger and more cosmetically acceptable materials have
enabled the industry to produce new O&P products, which provide greater
comfort, protection and patient acceptability. Therefore, treatment can
be more effective and of shorter duration, contributing to greater
mobility and a more active lifestyle for the patient. Orthotic devices
are more prevalent and visible in many sports, including skiing, running
and golf.
NEED FOR REPLACEMENT AND CONTINUING CARE. Because the useful life
of most custom fitted and fabricated O&P devices is approximately three
to five years, such devices need retrofitting and replacement. There is
also an attendant need for continuing patient-care services, which
contributes to the increasing demand for orthopedic rehabilitation.
INDUSTRY CONSOLIDATION
The O&P services market is highly fragmented and relatively
underpenetrated by professional practice management companies. Hanger is one
of the two largest companies in the O&P industry which, combined, accounted
for less than 15% of the total estimated O&P industry revenue in 1997. There
are an estimated 3,300 certified prosthetists and/or orthotists and
approximately 2,850 patient-care centers in the United States, with such
facilities generally being operated as small group practices. There are also
several regional and multi-regional competitors that operate numerous
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patient-care centers. The Company believes that the O&P industry will continue
to consolidate as a result of a variety of factors, including: (i) increased
pressures from growth in managed care; (ii) demonstrated benefits from
economies of scale; and (iii) desire by orthotists and prosthetists to obtain
financial liquidity and concentrate on providing patient care.
INCREASED MANAGED CARE PENETRATION. The expanding geographical reach of
the large managed care organizations makes it increasingly important for them
to contract for their patient-care needs with counterparts who have large,
national operations. Managed care companies therefore prefer to contract with
a single professional practice management company to provide all their O&P
patient-care services. As a result, small independent O&P practices feel
pressure to consolidate in order to access managed care referrals.
ECONOMIES OF SCALE. A significant portion of the cost of O&P services is
attributable to the cost of materials used in orthoses and prostheses.
Achieving purchase discounts through group purchasing can increase
profitability at each patient-care center. In addition, economies of scale
provide O&P practices with access to additional capital and personnel which
can be used in growing their businesses.
FINANCIAL LIQUIDITY FOR O&P PRACTICES. The security of a large O&P
network is extremely appealing to small providers who desire to reduce the
financial and personal liabilities of their practices. Through consolidation,
individual providers are able to realize financial liquidity by turning their
practices' cash flows into cash assets. This consolidation allows smaller
providers to continue their O&P practices as employees of a national O&P
professional practice management provider.
COMPANY STRATEGY
The Company's objective is to build a major national rehabilitation
company focused on the acquisition and operation of O&P practices and the
manufacture and distribution of O&P products. The Company's strategy for
achieving this objective is to:
* Acquire and integrate O&P practices in targeted geographic areas
across the United States;
* Develop new O&P patient-care centers in existing markets;
* Expand and improve O&P practice management operations at existing
and acquired patient-care centers;
* Increase OPNET's number of O&P patient-care service members and
its contractual relationships with managed care organizations; and
* Leverage and expand the Company's O&P manufacturing and
distribution operations.
ACQUIRE AND INTEGRATE O&P PRACTICES IN TARGETED GEOGRAPHICAL AREAS
ACROSS THE UNITED STATES. The Company's expansion is focused on developing a
national network providing O&P patient-care coverage. Therefore, when
identifying patient-care centers for acquisition, the Company seeks to fill
gaps in its existing geographic coverage. By focusing on national development,
the Company is well-positioned to negotiate for national contracts as payors
consolidate and look to large providers for services
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DEVELOP NEW O&P PATIENT-CARE CENTERS IN EXISTING MARKETS. In addition to
acquiring patient-care centers, the Company intends to open new patient-care
centers in existing markets. The Company plans to pursue this strategy by
opening satellite centers in areas where a need for O&P services has been
identified. In opening satellite patient-care centers, the Company's procedure
is to staff on a part-time basis with professionals from a nearby existing
center so as to test the viability of a full- time practice.
EXPAND AND IMPROVE O&P PRACTICE MANAGEMENT OPERATIONS AT EXISTING AND
ACQUIRED PATIENT-CARE CENTERS. As the number of Hanger patient-care centers
continues to increase, the benefits of the Company's practice management
operations will be maximized. The Company will be able to spread
administrative fixed costs and capital expenditures for state-of-the-art
equipment such as CAD/CAM systems over a large number of patient-care centers.
Furthermore, sales can also be enhanced by the Company's use of marketing
programs not generally utilized by practitioners in smaller, independent
practices.
INCREASE OPNET'S NUMBER OF O&P PATIENT-CARE SERVICE MEMBERS AND ITS
CONTRACTUAL RELATIONSHIPS WITH MANAGED CARE ORGANIZATIONS. The Company intends
to continue to expand OPNET membership in order to achieve complete nationwide
O&P patient-care coverage. A national network will enable OPNET to negotiate
for contracts with any local, regional or national third-party payor seeking a
single source O&P provider regardless of the payor's geographic scope.
LEVERAGE AND eXPAND THE COMPANY'S O&P MANUFACTURING AND DISTRIBUTION
OPERATIONS. As the patient-care practice management division of the Company
expands, it can create captive demand for the company's distribution business.
An increase in the number of OPNET members, to whom preferred purchasing
agreements are offered, can also increase net sales for the Company's
distribution business. The Company's manufacturing division can also benefit
from increased net sales at the distribution division by providing proprietary
products to meet the demand of an expanded captive market. The Company's
manufacturing efforts will focus on the acquisition and/or development of
proprietary patented products such as the Lenox Hill knee brace and the
Charleston Bending Brace.
PRACTICE MANAGEMENT AND PATIENT-CARE SERVICES
PRACTICE MANAGEMENT SERVICES
The Company provides all senior management, accounting, accounts
payable, payroll, sales and marketing, human resources and management
information systems for its patient-care centers. By providing these services
on a centralized basis, the Company is able to provide such services to its
patient-care centers and practitioners more efficiently and cost-effectively
than if such services had to be generated at each center. The centralization
of these services also permits the Company's certified practitioners to
allocate a greater portion of their time to patient-care activities by
reducing the administrative responsibilities of operating their businesses.
Billing and collections are handled on a decentralized basis, which the
Company believes enhances collectibility.
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The Company also develops and implements programs designed to enhance
the efficiency of its clinical practices. Such programs include: (i) sales and
marketing initiatives to attract new-patient referrals by establishing
relationships with physicians, therapists, employers, managed care
organizations, hospitals, rehabilitation centers, out-patient clinics and
insurance companies; (ii) professional management and information systems to
improve efficiencies of administrative and operational functions; (iii)
professional education programs for practitioners emphasizing new developments
in the increasingly sophisticated field of O&P clinical therapy; (iv) the
regional centralization of fabrication and purchasing activities, which
provides overnight access to component parts and products at prices that are
typically 25% lower than traditional procurement methods; and (v) access to
expensive, state-of-the-art equipment which is financially more difficult for
smaller, independent facilities to obtain.
The Company believes that the application of sales and marketing
techniques is a key element of its O&P professional practice management
strategy. Due primarily to the fragmented nature of the industry, the success
of an O&P practice has been largely a function of its local reputation for
quality of care, responsiveness and length of service in the community.
Individual practitioners have relied almost exclusively on referrals from
local physicians or physical therapists and typically have not used marketing
techniques.
PATIENT-CARE SERVICES
At December 31, 1998, the Company provided O&P patient-care services
through 256 Company-owned and operated O&P patient-care centers in 30 states
and the District of Columbia. Hanger employed 356 patient-care practitioners,
of whom 321 were certified practitioners and 34 were candidates for formal
certification by the O&P industry certifying boards as of that date. Each of
the Company's patient-care centers is closely supervised by one or more
certified practitioners. The balance of the Compan s patient-care
practitioners are highly trained technical personnel who assist in the
provision of services to patients and fabricate various O&P devices.
A patient is referred to one of Hanger's patient-care centers for
treatment upon a determination by the attending physician of a course of
treatment for a patient in need of O&P patient-care services. A Hanger
practitioner then consults with both the referring physician and the patient
to formulate the prescription for, and design of, an orthotic or prosthetic
device to meet the patient's needs.
The fitting process involves several stages in order to successfully
achieve desired functional and cosmetic results. The practitioner creates a
cast and takes detailed measurements of the patient to ensure an anatomically
correct fit. All of the prosthetic devices fitted by Hanger's practitioners
are custom designed and fabricated by skilled practitioners who can balance
fit, support and comfort. Of the orthotic devices provided by Hanger,
approximately 75% are custom designed, fabricated and fitted and the balance
is prefabricated but custom fitted.
Custom devices are fabricated by the Company's skilled technicians using
the castings, measurements and designs made by the practitioner. Technicians
use advanced materials and technologies to fabricate a custom device under
quality assurance guidelines. After final adjustments to the device by the
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practitioner, the patient is instructed in the use, care and maintenance of
the device. A program of scheduled follow-up and maintenance visits is used to
provide post-fitting treatment, including adjustments or replacements as the
patient's physical condition and lifestyle change.
A substantial portion of Hanger's O&P services involves treatment of a
patient in a non-hospital setting, such as a Hanger patient-care center, a
physician's office, an out-patient clinic or other facility. In addition, O&P
services are increasingly rendered to patients in hospitals, nursing homes,
rehabilitation centers and other alternate-site healthcare facilities. In a
hospital setting, the practitioner works with a physician to provide either
orthotic devices or temporary prosthetic devices that are later replaced by
permanent prostheses.
The Company also operates in-patient O&P patient-care centers at The
Rusk Institute of Rehabilitation Medicine at the New York University Medical
Center in New York, New York and the Harmarville Rehabilitation Center in
Pittsburgh, Pennsylvania,
OPNET
In 1995, Hanger formed OPNET, a proprietary national preferred provider
O&P referral network serving managed care organizations, including HMOs and
PPOs. Through this network, managed care organizations can contract for O&P
services with any O&P patient-care center in the OPNET network. As of December
31, 1998, OPNET had a network of 390 patient-care centers (256 of which are
owned and operated by the Company) serving 353 managed care plans. The Company
intends to extend the network's reach nationwide through acquisitions and
marketing. OPNET also provides incentives to independent O&P service provider
members to purchase their O&P products from the Company. The Company receives
up-front annual payments from practitioners to enter the OPNET network; OPNET
does not receive payments from the managed care participants. Total 1998 net
sales from these fees were approximately $226,000. The Company believes that
OPNET's membership enables the Company to establish significant relationships
with practitioners otherwise not affiliated with it.
MANUFACTURING AND DISTRIBUTION
In addition to on-site fabrication of custom O&P devices incidental to
the services rendered at its O&P patient-care centers, the Company
manufactures O&P components and finished patient-care products for both the
O&P industry and the Company's own patient-care practices. The Company
manufactures components and finished products under various name brands such
as Lenox Hill, CASH Brace, Ortho-Mold, Charleston Bending Brace, DOBI-Symplex,
Seattle Limb Systems and Sea Fab. The principal products manufactured are
prefabricated and custom-made spinal orthoses as well as custom-made and
off-the-shelf derotation knee braces. The Company distributes O&P components
and finished patient-care products to the O&P industry and to the Company's
own patient-care practices. The Company inventories over 20,000 items, a
majority of which are manufactured by other companies and are distributed by
Hanger. During 1998, Hanger acquired Model and Instrument Development
Corporation, a manufacturing facility located in Seattle, Washington which
operated under the trade name of Seattle Limb Systems and manufactured
prosthetic and related equipment.
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Hanger's distribution capability allows its personnel faster access to
the products needed to fabricate devices for patients. This is accomplished at
competitive prices, as a result of either manufacturing by Hanger or direct
purchases by Hanger from other manufacturers. As a result of faster access to
products, the length of a patient's treatment in the hospital can be reduced,
thereby contributing to healthcare cost containment.
Marketing of Hanger's manufactured products and distribution services is
conducted on a national basis, primarily through approximately 32 sales
representatives, catalogues and exhibits at industry and medical meetings and
conventions. Hanger directs specialized catalogues to segments of the
healthcare industry, such as orthopedic surgeons and physical and occupational
therapists. In addition, the Company directs its broad-based marketing to the
O&P industry and the home health care industry.
To provide timely custom fabrication and service to its patients, the
Company employs technical personnel and maintains laboratories at each of its
patient-care centers. The Company uses advanced computer-aided design and
computer-aided machinery (CAD-CAM) technology to produce precise and uniform
products. Hanger has several large, fully-staffed central fabrication
facilities to service its patient-care centers. These strategically located
facilities enable Hanger to fabricate those O&P products that are more easily
produced in larger quantities and in a more cost-effective manner, as well as
serving as an auxiliary production center for products normally fabricated at
individual patient-care centers.
ACQUISITIONS
Since 1986, the Company has acquired over 75 businesses in 30 states and
the District of Columbia. In November 1996, Hanger acquired JEH, a Georgia
corporation that operated 96 patient-care centers in 15 states and was the
country's largest distributor of O&P products.
During 1997, the Company acquired nine O&P companies and the remaining
20% interest of its majority owned subsidiary, Columbia Brace, for an
aggregate consideration, excluding potential earn-out provisions, of $22.5
million. These O&P companies operated 29 patient-care centers and employed 175
employees at December 31, 1997.
During 1998, the Company acquired 17 O&P companies for an aggregate
consideration, excluding potential earn-out provisions, of $25.3 million.
These O&P companies operated 39 patient-care centers and employed 189
employees at December 31, 1998. In addition, the Company acquired one
prosthetic component manufacturing company for $13.8 million during 1998.
The Company continues to be engaged in discussions with several O&P
companies relating to the Company's possible acquisition of their patient-care
practices. The Company's investigations of these businesses are in the
formative stages and no representations can be made as to whether, when or on
what terms such possible acquisitions may be effected.
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The Company considers both operating and financial factors in evaluating
prospective acquisitions. Operating factors include high standards of
professionalism and patient care, the presence of certified practitioners at
each of its facilities and reputation in the O&P industry. Financial factors
include earnings and cash flow history and the projected benefits of applying
Hanger's operating model to the acquired company's practice. In evaluating
acquisitions in geographic areas where the Company has an established
presence, Hanger targets businesses that complement its existing network of
patient-care centers. In geographic areas where the Company has not yet
established a presence, the Company generally focuses on acquiring strong
regional businesses which have multiple patient-care centers and experienced
practitioners.
The Company's acquisition strategy also includes the retention and
support of the existing management of the acquired company, typically through
the use of employment contracts, non-compete agreements and incentive
programs. Upon the completion of an acquisition, the Company will integrate
the business of the acquired company by: (i) transferring all administrative
and financial management responsibilities to Hanger's corporate headquarters;
(ii) providing all new personnel with compensation and benefit packages and
training by the Company's Human Resources Department; and (iii) providing the
management of the acquired company with instruction on the Company's latest
marketing and sales techniques. Thereafter, the Company will provide the
management and staff of the newly acquired company with financial incentives
to induce greater financial performance.
NEW-CENTER DEVELOPMENT
In addition to acquired patient-care centers, the Company develops new
satellite patient-care centers in existing markets with underserved demand for
O&P services. These satellite centers require less capital to develop than
complete O&P centers since the satellite centers usually consist of only a
waiting room and patient fitting rooms, but without a fabrication laboratory
for creating O&P devices. An O&P practitioner will spend one or two days each
week in a satellite center treating those patients who find it inconvenient to
visit the O&P practitioner's primary center.
These satellite centers also tend to receive new patient referrals from
hospitals and physicians located near the newly-developed center, driving new
patient growth and center revenue. While a partial revenue shift occurs from
the O&P practitioner's main center to the satellite center because the O&P
practitioner is now seeing some of the same patients out of a new center, the
additional patient volume in the satellite center increases the O&P
practitioner's overall revenue. If demand for O&P services at a satellite
center increases beyond the ability of the O&P practitioner to service in one
or two days a week, the company will staff the satellite office on a full-time
basis. The Company estimates that the cost of opening a new patient-care
center is approximately $100,000, which includes equipment, leasehold
improvements and working capital. The Company expects a new patient-care
center to reach profitability, as measured by EBITDA, within one year of
opening. No assurance can be given that the Company will be successful in
achieving these start-up and profitability goals with regard to new
patient-care centers.
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PATIENT REIMBURSEMENT SOURCES
The principal reimbursement sources for Hanger's O&P services are: (i)
private payor/third-party insurer sources which consist of individuals,
private insurance companies, HMOs, PPOs, hospitals, vocational rehabilitation,
workers' compensation and similar sources; (ii) Medicare, which is a federally
funded health insurance program providing health insurance coverage for
persons aged 65 or older and certain disabled persons; (iii) Medicaid, which
is a health insurance program jointly funded by federal and state governments
providing health insurance coverage for certain persons in financial need,
regardless of age, and which may supplement Medicare benefits for financially
needy persons aged 65 or older; and (iv) the VA, with which Hanger has entered
into contracts to provide O&P services.
Medicare, Medicaid, the VA and certain state agencies, which accounted
for approximately 56.8%, 62.0% and 53.7% of the Company's net sales in 1996,
1997 and 1998, respectively, (based on a sampling of approximately 75%, 75%
and 41% of patient-care centers in 1996, 1997 and 1998, respectively) have set
maximum reimbursement levels for payments for O&P services and products. The
healthcare policies and programs of these agencies have been subject to
changes in payment and methodologies during the past several years. There can
be no assurance that future changes will not reduce reimbursements for O&P
services and products from these sources.
The Company provides O&P services to eligible veterans pursuant to
several contracts with the VA. The VA establishes its reimbursement rates for
itemized products and services on a competitive bidding basis. The Company's
contracts with the VA expire in September 1999, with the option to renew for a
one- or two-year period. The contracts, awarded on a non-exclusive basis,
establish the amount of reimbursement to the eligible veteran if the veteran
should choose to use the Company's products and services. The Company has been
awarded VA contracts in the past and expects that it will obtain additional
contracts when its present agreements expire.
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PATIENT-CARE CENTERS AND FACILITIES
As of December 31, 1998, Hanger operated 256 patient-care centers, six
distribution facilities and three manufacturing facilities, as detailed in the
following table:
<TABLE>
<CAPTION>
Patient-
Care Distribution Manufacturing
Jurisdiction Centers Facilities Facilities
------------ ------- ------------ --------------
<S> <C> <C> <C>
Alabama 16 --- ---
Arizona 4 --- ---
California 5 1 ---
Colorado 5 --- ---
Connecticut 13 --- ---
Delaware 1 --- ---
District of Columbia 2 --- ---
Florida 35 1 1
Georgia 21 1 ---
Illinois --- 1 1
Indiana 3 --- ---
Kansas 3 --- ---
Kentucky 7 --- ---
Louisiana 9 --- ---
Maryland 7 1 ---
Massachusetts 3 --- ---
Michigan 3 --- ---
Mississippi 8 --- ---
Montana 6 --- ---
Nevada 2 --- ---
New Hampshire 1 --- ---
New Mexico 1 --- ---
New York 8 --- ---
North Carolina 3 --- ---
Ohio 20 --- ---
Pennsylvania 22 --- ---
South Carolina 11 --- ---
Tennessee 10 --- ---
Texas 13 1 ---
Virginia 6 --- ---
West Virginia 6 --- ---
Washington --- --- 1
Wyoming 2 --- ---
----- ----- -----
TOTAL 256 6 3
===== ===== =====
</TABLE>
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COMPETITION
The competition among O&P patient-care centers is primarily for
referrals from physicians, therapists, employers, HMOs, PPOs, hospitals,
rehabilitation centers, out-patient clinics and insurance companies on both a
local and regional basis. The Company believes that distinguishing competitive
factors in the O&P industry are quality and timeliness of patient care and, to
a lesser degree, charges for services. While the Company believes it is one of
the largest suppliers of O&P services in the U.S., certain competitors may
have greater financial and personnel resources than Hanger. The Company
competes with others in the industry for trained personnel. To date, however,
Hanger has been able to achieve its staffing needs and has experienced a
relatively low turnover rate of employees. In connection with its efforts to
acquire additional O&P patient-care practices, the Company encounters
competition from several other O&P companies.
GOVERNMENT REGULATION
CERTIFICATION AND LICENSURE
Most states do not require separate licensure for O&P practitioners.
However, several states currently require O&P practitioners to be certified by
an organization such as the American Board for Certification ("ABC").
The ABC conducts a certification program for practitioners and an
accreditation program for patient-care centers. The minimum requirements for a
certified practitioner are a college degree, completion of an accredited
academic program, one to four years of residency at a patient-care center
under the supervision of a certified practitioner and successful completion of
certain examinations. Minimum requirements for an ABC-accredited patient-care
center include the presence of a certified practitioner and specific plant and
equipment requirements. While the Company endeavors to comply with all state
licensure requirements, no assurance can be given that the Company will be in
compliance at all times with these requirements.
Hanger provides services under various contracts to federal agencies.
These contracts are subject to regulations governing federal contracts,
including the ability of the government to terminate for its convenience.
MEDICAL DEVICE REGULATION
The Company manufactures and distributes products that are subject to
regulation as medical devices by the Food and Drug Administration ("FDA")
under the Federal Food, Drug, and Cosmetic Act and accompanying regulations.
The Company believes that the products it manufactures and/or distributes,
including O&P accessories and components, are exempt from FDA's regulations
for premarket clearance or approval requirements and from requirements
relating to "good manufacturing practices: (except for certain recordkeeping
and complaint handling requirements). The Company is required to adhere to
regulations regarding adverse event reporting, and is subject to inspection by
the FDA for compliance with all applicable requirements. Labeling and
promotional materials also are subject to scrutiny by the FDA and, in certain
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circumstances, by the Federal Trade Commission. Although the Company has never
been challenged by FDA for noncompliance with FDA requirements, no assurance
can be given that the Company would be found to be or to have been in
compliance at all times. Noncompliance could result in a variety of civil
and/or criminal enforcement actions, which could have a material adverse
effect on the Company's business and results of operations.
FRAUD AND ABUSE
The Company is subject to various federal and state laws pertaining to
healthcare fraud and abuse, including antikickback laws, false claims laws,
and physician self-referral laws. Violations of these laws are punishable by
criminal and/or civil sanctions, including, in some instances, imprisonment
and exclusion from participation in federal healthcare programs, including
Medicare, Medicaid, VA health programs and CHAMPUS. The Company has never been
challenged by a governmental authority under any of these laws and believes
that, based on this history, its operations are in material compliance with
such laws. However, because of the far-reaching nature of these laws, there
can be no assurance that one or more of the Company's practices would not be
required to alter its practices as a result, or that the occurrence of one or
more of these events would not result in a material adverse effect on the
Company's business and results of operations.
ANTIKICKBACK LAWS. The Company's operations are subject to federal and
state antikickback laws. The Federal Health Care Programs Antikickback Statute
(section 1128B(b) of the Social Security Act) prohibits persons or entities
from knowingly and willfully soliciting, offering, receiving, or paying any
remuneration in return for, or to induce, the referral of persons eligible for
benefits under a Federal Health Care Program (including Medicare, Medicaid,
the VA health programs and CHAMPUS), or the ordering, purchasing or leasing of
items or services that may be paid for, in whole or in part, by a Federal
Health Care Program. The statute may be violated when even one purpose (as
opposed to a primary or sole purpose) of a payment is to induce referrals or
other business. Regulations create a small number of "safe harbors." Practices
which meet all the criteria of an applicable safe harbor will not be deemed to
violate the statute; practices that do not satisfy all elements of a safe
harbor do not necessarily violate the statute, although such practices may be
subject to scrutiny by enforcement agencies. Several states also have
antikickback laws which vary in scope and may apply regardless of whether a
Federal Health Care Program is involved.
These laws may apply to certain of the Company's operations. The Company
has instituted various types of discount programs for individuals or entities
that purchase its products and services. The Company also maintains financial
relationships with individuals and entities who may: (i) purchase the
Company's products and services; (ii) refer patients to Company-owned and
managed O&P patient-care centers; or (iii) receive referrals through OPNET.
These relationships include, among other things, lease arrangements with
hospitals and OPNET participation arrangements. Because some of these
arrangements may not satisfy all elements of an applicable safe harbor, they
could be subject to scrutiny and challenge under one or more such laws.
12
<PAGE>
FALSE CLAIMS LAWS. The Company is also subject to federal and state laws
prohibiting individuals or entities from knowingly and willfully presenting,
or causing to be presented, claims for payment to third-party payors
(including Medicare and Medicaid) that are false or fraudulent or are for
items or services not provided as claimed. Each Company-owned and managed O&P
patient-care center is responsible for preparation and submission of
reimbursement claims to third-party payors for items and services furnished to
patients. In addition, Company personnel may, in some instances, provide
advice on billing and reimbursement for the Company's products to purchasers.
While the Company endeavors to ensure that its billing practices comply with
applicable laws, if claims submitted to payors are deemed to be false,
fraudulent, or for items or services not provided as claimed, the Company
could face liability for presenting or causing to be presented such claims.
PHYSICIAN SELF-REFERRAL LAWS. The Company is also subject to federal and
state physician self-referral laws. With certain exceptions, the federal
Medicare/Medicaid physician self-referral law (the "Stark" law, section 1877
of the Social Security Act) prohibits a physician from referring Medicare and
Medicaid beneficiaries to an entity for "designated health services" -
including prosthetics, orthotics and prosthetic devices and supplies - if the
physician has either an investment interest in the entity or a compensation
arrangement with the entity. An exception is recognized for referrals made to
a publicly-traded entity in which the physician has an investment interest if,
among other things, the entity had shareholders' equity exceeding $75.0
million for its most recent fiscal year, or on average during the three
previous fiscal years. While the Company does not provide stock to referring
physicians and the Company's stock is publicly-traded, the Company is not in a
position to know or control whether some referring physicians may be
investors. Because the Company does not currently have sufficient
shareholders' equity to meet the exception that would allow
physician-investors to refer Medicare and Medicaid beneficiaries to
Company-owned and managed O&P patient-care centers, and any such referrals
that do occur could be found to be in violation of the Stark law.
ANTITRUST
The Company is subject to federal and state antitrust laws which
prohibit, among other things, the establishment of ventures that result in
certain anticompetitive conduct. These laws have been applied to the
establishment of certain networks of otherwise competing healthcare provider.
In September 1995, the Antitrust Division of the Department of Justice ("DOJ")
issued a business review letter which concluded, in part, that the description
of OPNET voluntarily furnished to the DOJ by the Company "did not pose any
significant competitive issues" and, therefore, DOJ "has no present intention
of challenging [OPNET]" under federal antitrust law. Although the Company is
not able to assure that the continued operation of OPNET will comply in all
respects with the terms specified in the business review letter, noncompliance
with these terms does not mean that the antitrust authorities or private
parties would challenge the conduct, and the Company believes that the current
operation of OPNET is not anticompetitive and results in significant
efficiencies. However, DOJ reserves the right to bring an investigation or
proceeding if it determines that OPNET is anticompetitive in purpose or
effect. There can be no assurance that DOJ will not bring an investigation or
proceeding challenging OPNET (or other aspects of the Company's operations)
under these laws, or that such an investigation or proceeding would not result
in a material adverse effect on the Company's business and results of
operations.
13
<PAGE>
PERSONNEL
As of December 31, 1998, the Company employed 1,437 persons, including
1,324 full-time and 113 part-time employees. None of the Company's employees
is subject to a collective bargaining agreement. The Company believes that it
has satisfactory relationships with its employees and strives to maintain
these relationships by offering competitive benefit packages, training
programs and opportunities for advancement.
INSURANCE
The Company currently maintains insurance of the type and in the amount
customary in the orthopedic rehabilitation industry, including coverage for
malpractice liability, product liability, workers' compensation and property
damage. Hanger's general liability insurance coverage is at least $500,000 per
incident. Based on the Company's experience and prevailing industry practices,
Hanger believes its coverage is adequate as to risks and amount.
ITEM 2. PROPERTIES.
As of December 31, 1998, Hanger operated 256 patient-care centers and
facilities in 30 states and the District of Columbia. Of these, 30 centers are
owned by Hanger. The remaining centers are occupied under leases expiring
between the years of 1999 and 2008. Hanger believes that the centers leased or
owned by it are adequate for carrying on its current O&P operations at its
existing locations, as well as its anticipated future needs at those
locations. Hanger believes it will be able to renew such leases as they expire
or find comparable or additional space on commercially suitable terms.
Hanger also owns distribution facilities in Georgia and Texas, and
leases manufacturing and distribution facilities in Illinois, Maryland,
Florida, Washington and California. The Company leases its corporate
headquarters in Bethesda, Maryland and owns its corporate office in
Alpharetta, Georgia. Substantially all of Hanger's properties are pledged to
collateralize bank indebtedness. See Note G to Hanger's Consolidated Financial
Statements.
ITEM 3. LEGAL PROCEEDINGS.
Legal proceedings to which Hanger is subject arise in the ordinary
course of business. Currently, Hanger is not a party to any material legal
proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted during the fourth quarter of the fiscal year
covered by this report to a vote of stockholders.
14
<PAGE>
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table sets forth information regarding the current
executive officers of the Company and certain of its subsidiaries:
<TABLE>
<CAPTION>
Office with
Name Age the Company
------ ----- -------------
<S> <C> <C>
Ivan R. Sabel, CPO 54 Chairman of the Board, President, Chief Executive
Officer and Director of the Company
Richard A. Stein 39 Vice President-Finance, Secretary and Treasurer
of the Company
John D. McNeill, CPO 51 President and Chief Operating Officer of
Hanger Prosthetics & Orthotics, Inc.
James G. Cairns, Jr. 61 President and Chief Operating Officer of
Seattle Orthopedic Group, Inc.
Jeffrey L. Martin 45 Vice President of OPNET, Inc.
</TABLE>
IVAN R. SABEL has been Chairman of the Board and Chief Executive Officer
of Hanger since August 1995 and President of Hanger since November 1987. Mr.
Sabel also served as the Chief Operating Officer of Hanger from November 1987
to August 1995. Prior to that time, Mr. Sabel had been Vice President -
Corporate Development from September 1986 to November 1987. From 1968 until
joining Hanger in 1986, Mr. Sabel was the founder and President of Capital
Orthopedics, Inc. before that company was acquired by Hanger. Mr. Sabel is a
Certified Prosthetist and Orthotist ("CPO"), a clinical instructor in
orthopedics at Georgetown University Medical School in Washington, D.C., a
member of the Board of Directors of the American Orthotic and Prosthetic
Association, a former Chairman of the National Commission for Health
Certifying Agencies, a former member of the Strategic Planning Committee and a
current member of the Veterans Administration Affairs Committee of AOPA and a
former President of the ABC.
RICHARD A. STEIN has been Vice President-Finance, Secretary and
Treasurer of Hanger since April 1987. Mr. Stein was also the President of
Greiner & Saur Orthopedics, Inc., a former subsidiary of the Company, from
April 1987 until November 1989. Mr. Stein is a Certified Public Accountant and
was employed by PricewaterhouseCoopers L.L.P. (formerly Coopers & Lybrand,
L.L.P.) from September 1982 until he joined Hanger in 1987.
JOHN D. MCNEILL, CPO has been the President and Chief Operating Officer
of Hanger Prosthetics & Orthotics, Inc., a wholly-owned subsidiary of the
Company that operates the Company's patient-care centers, since November 1,
1996. From 1990 to November 1, 1996, he was Senior Vice President, Chief
Operating Officer and a director of JEH. From 1986 to 1990, Mr. McNeill was a
15
<PAGE>
Regional Vice President and an area manager for JEH. Mr. McNeill, who is a
CPO, conducted his own O&P practice in Marietta, Georgia from 1979 to 1986,
when it was acquired by JEH.
JAMES G. CAIRNS, JR. has served as the President and Chief Operating
Officer of Seattle Orthopedic Group, Inc., a wholly-owned subsidiary of the
Company that designs, manufactures and distributes orthotic and prosthetic
products, since the Company's acquisition of Model and Instrument Development
Corporation in August 1998, of which he had served as the President and Chief
Executive Officer since 1992. Model and Instrument Development Corporation
operated under the trade style Seattle Limb Systems and manufactured
prosthetic components and related equipment. Previously, he served from 1987
to 1992 as the Chairman of the Board and Chief Executive Officer of Alliance
Bancorporation, a bank holding company, and earlier as a consultant to the
financial services industry and in management positions with various banking
organizations.
JEFFREY L. MARTIN has been the Vice President of OPNET, the Company's
preferred provider network of O&P service professionals, since October 1995.
In addition to being responsible for the recruitment of OPNET members and the
planning and implementation of OPNET member services Mr. Martin directs the
solicitation and management of OPNET managed care contracts. From 1984 until
joining Hanger in 1995, Mr. Martin was Director of Marketing for the Ohio
Willow Wood Company, a manufacturer of prosthetic componentry.
EMPLOYMENT AND NON-COMPETE AGREEMENTS
Messrs. Sabel, Stein, McNeill and Cairns have executed employment
agreements with the Company which contain non-compete provisions.
16
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
The Company's Common Stock has been listed and traded on the New York
Stock Exchange since December 15, 1998, under the symbol "HGR." The following
table sets forth the high and low intra-day sale prices for the Common Stock
for the periods indicated as reported on the New York Stock Exchange on and
after December 15, 1998, and on the American Stock Exchange prior thereto:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997 HIGH LOW
---- ---
<S> <C> <C>
First Quarter $ 7.00 $ 5.50
Second Quarter 9.25 6.25
Third Quarter 14.94 8.44
Fourth Quarter 14.63 10.56
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 HIGH LOW
---- ---
<S> <C> <C>
First Quarter $17.63 $12.25
Second Quarter 21.00 16.00
Third Quarter 22.25 14.50
Fourth Quarter 25.88 14.75
</TABLE>
At March 17, 1999, there were approximately 821 holders of record of
Common Stock.
DIVIDEND POLICY
The Company has never paid cash dividends on its Common Stock and
intends to continue this policy for the foreseeable future. Hanger plans to
retain earnings for use in its business. The terms of Hanger's agreements with
its financing sources and certain other agreements prohibit the payment of
dividends on its Common Stock and Preferred Stock and such agreements will
continue to prohibit the payment of dividends in the future. Any future
determination to pay cash dividends will be at the discretion of the Board of
Directors of the Company and will be dependent on Hanger's results of
operations, financial condition, contractual and legal restrictions and any
other factors deemed to be relevant.
17
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL INFORMATION.
The selected consolidated financial data presented below is derived from
the audited Consolidated Financial Statements and Notes thereto included
elsewhere in this report.
18
<PAGE>
<TABLE>
<CAPTION>
SELECTED FINANCIAL STATEMENTS
(In thousands, except per share data)
Years Ended December 31,
------------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net sales $ 50,300 $ 52,468 $ 66,806 $145,598 $187,870
Gross profit 27,091 27,896 34,573 72,065 94,967
Selling, general & administrative 21,340 19,362 24,550 49,076 63,512
Depreciation and amortization 3,137 2,691 2,848 4,681 5,782
Acquisition and integration costs (1) --- --- 2,480 --- ---
Restructuring cost (1) 460 --- --- --- ---
Loss from disposal of assets (1) 2,150 --- --- --- ---
Income from continuing operations 4 5,843 4,695 18,308 25,673
Interest expense, net (1,746) (2,056) (2,547) (4,932) (1,902)
Income (loss) from continuing operations
before taxes, extraordinary item (1,922) 3,680 1,971 13,166 23,456
Provision for income taxes 358 1,545 890 5,526 9,616
Income (loss) from continuing operations
before extraordinary item (2,280) 2,135 1,081 7,640 13,840
Loss from discontinued operations (2) (407) --- --- --- ---
Income (loss) before extraordinary
Item (2,687) 2,135 1,081 7,640 13,840
Extraordinary loss on early
extinguishment of debt --- --- (83) (2,694) ---
Net income (loss) $ (2,687) $ 2,135 $ 998 $ 4,946 $ 13,840
BASIC PER COMMON SHARE DATA:
Income (loss) from continuing operations
before extraordinary item $ (0.28) $ 0.25 $ 0.12 $ 0.65 $ 0.82
Loss from discontinued operations (0.05) --- --- --- ---
Extraordinary loss on early
extinguishment of debt --- --- (0.01) (0.23) ---
Net income (loss) per common share $ (0.33) $ 0.25 $ 0.11 $ 0.42 $ 0.82
========= ========= ========= ========= =========
Shares used to calculate basic per common
share amounts 8,290 8,291 8,470 11,793 16,813
========= ========= ========= ========= =========
DILUTED PER COMMON SHARE DATA:
Income (loss) from continuing operations
Before extraordinary item $ (0.28) $ 0.25 $ 0.12 $ 0.58 $ 0.75
Loss from discontinued operations (0.05) --- --- --- ---
Extraordinary loss on early extinguishment
of debt --- --- (0.01) (0.21) ---
Net income (loss) per common share $ (0.33) $ 0.25 $ 0.11 $ 0.37 $ 0.75
========= ========= ========= ========= =========
Shares used to calculate diluted per common
share amounts 8,290 8,300 8,663 13,138 18,516
========= ========= ========= ========= =========
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------------
BALANCE SHEET DATA: 1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents $ 1,048 $ 1,456 $ 6,572 $ 6,557 $ 9,683
Working capital 18,412 20,622 25,499 39,031 49,678
Total assets 61,481 61,800 134,941 157,983 205,948
Long-term debt 24,330 22,925 64,298 23,237 11,154
Shareholders' equity 29,178 31,291 39,734 106,320 162,553
<FN>
(1) The 1994 results include restructuring costs of $460,000
associated with the closing of unprofitable patient-care centers
and a loss from the disposal of assets of $2.2 million resulting
from the sale of the Company's southern California patient-care
centers. The 1996 results include acquisition and integration
costs of $2.5 million incurred in connection with the purchase of
JEH effective November 1, 1996.
(2) Loss from discontinued operations consists of the loss from
discontinued operations and the sale of the discontinued operation
of the Company's Apothecaries, Inc. subsidiary, the assets of
which were sold in 1994.
</FN>
</TABLE>
20
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
OVERVIEW
The significant growth in the Company's O&P professional practice
management net sales has resulted from an aggressive program of acquiring and
developing O&P patient-care centers. Similarly, growth in the Company's O&P
distribution and manufacturing net sales is attributable primarily to
acquisitions. At December 31, 1998, the Company operated 256 patient-care
centers, six distribution facilities, three of which contain central
fabrication operations, and 3 manufacturing facilities.
COMPANY EXPANSION
During late 1994 and 1995, the Company closed or sold nine unprofitable
patient-care centers and temporarily discontinued its acquisition program.
Following a change in executive management in mid-1995 and a refinancing in
1996, the Company's acquisition program was resumed. The significant increase
in the number of patient-care center and certified practitioners in 1996 is
attributable primarily to the Company's acquisition of J.E. Hanger, Inc. of
Georgia ("JEH"). The following table sets forth the number of patient-care
centers, certified practitioners and states (including the District of
Columbia) in which the company operated at the end of each of the past five
years:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Number of patient-care centers 85 84 178 213 256
Number of certified practitioners 125 119 199 249 321
Number of states (including D.C.) 25 24 29 30 31
</TABLE>
21
<PAGE>
NON-RECURRING CHARGES
The Company's results of operations prior to 1997 were adversely
affected by certain non-recurring charges, the most significant of which were
associated with: (i) the sale or closure of unprofitable patient-care centers
and related restructuring charges recorded in 1994; and (ii) non-recurring
acquisition and integration costs incurred in 1996 in connection with the
acquisition of JEH. The following table sets forth the Company's income from
continuing operations, both as reported and excluding non-recurring charges,
during each of the past five years:
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C>
Income from continuing operations (as
reported) $ 4 $ 5,843 $ 4,695 $18,308 $25,673
Non-recurring charges:
Loss from disposal of assets: 2,150 - - - -
Restructuring costs 460 - - - -
Acquisition and integration costs - - 2,480 - -
-------- -------- -------- -------- --------
Income from continuing operations
(excluding non-recurring charges) $ 2,614 $ 5,843 $ 7,175 $18,308 $25,673
</TABLE>
RECENT ACQUISITIONS
During 1998, the Company acquired 17 O&P companies for an aggregate
consideration, excluding potential earn-out provisions of $25.3 million. These
O&P companies operated 39 patient-care centers and employed 189 persons at
December 31, 1998. In addition, the Company acquired one prosthetic component
manufacturing company for $13.8 million.
SAME-CENTER SALES GROWTH
In addition to acquisitions of new patient-care centers, the growth in
the Company's net sales from O&P patient-care services is attributable to a
lesser degree to increases in net sales from existing patient-care centers. In
1994, the Company's decline in same-center net sales growth was primarily a
result of poor operating performance at several centers that the Company
subsequently sold or closed, the loss of several practitioners and severe
weather conditions in the first quarter. The following table sets forth, for
the periods indicated, the percent increase (decrease) in net sales
contributed by those patient-care centers that were open during the entire
period as well as the prior year's entire comparable period:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Percent increase (decrease) in same-center
sales (3.7)% 5.2% 5.8% 11.7% 11.1%
</TABLE>
22
<PAGE>
SOURCES OF NET SALES
Although the Company's net sales continue to be most significantly
derived from O&P practice management activities, including patient-care
services, the percent of the Company's total net sales attributable to O&P
distribution activities has increased. The following table sets forth the
percent contributed to net sales in each of the periods indicated by the
principal sources of the Company's net sales. The increase in the percentage
of net sales contributed by distribution activities in 1997 is attributable to
the Company's acquisition of JEH in late 1996 and increased sales to O&P
practitioners in the Company's OPNET network. Manufacturing as a percent of
net sales declined to 4.5% in 1998 versus 5.3% in 1997. However, there was an
increase in the actual dollar amount of net sales attributable to
manufacturing.
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Source of net sales:
Practice management and
Patient-care services 78.0% 78.5% 78.6% 77.1% 81.1%
Manufacturing 17.6 16.3 12.0 5.3 4.5
Distribution 4.4 5.2 9.4 17.6 14.4
------ ------ ------ ------ ------
100.0% 100.0% 100.0% 100.0% 100.0%
====== ====== ====== ====== ======
</TABLE>
PAYOR MIX
The Company receives payments for O&P services rendered to patients from
private insurers, HMOs, PPOs, the patients directly and governmental payors,
including Medicare, Medicaid and the VA. The sources and amounts of the
Company's net sales derived from its patient-care centers are determined by a
number of factors, including the number and nature of O&P services rendered
and the rates of reimbursement among payor categories. Generally, private
insurance and other third-party reimbursement levels are greater than managed
care (HMO/PPO), Medicare, Medicaid and VA reimbursement levels. Changes in the
Company's payor mix can affect its profitability. The following table sets
forth the percent contributed to net sales in each of the following periods by
the principal categories of payors:
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Payor mix(1):
Private pay and other 43.2% 38.0% 46.3%
Medicare/Medicaid/VA 56.8% 62.0% 53.7%
------ ------ ------
100.0% 100.0% 100.0%
====== ====== ======
<FN>
(1) Payor mix data is based on a sampling of approximately 75% of the
patient care centers in 1996 and 1997 and approximately 41% of the
patient-care centers in 1998.
</FN>
</TABLE>
23
<PAGE>
EBITDA AND OPERATING MARGIN TRENDS
The Company's EBITDA and operating margins have fluctuated over the past
five years. In 1994, margins decreased due to the loss of several
practitioners, poor operating performance at several centers and severe
weather in the first quarter of the year. In 1995, margins increased due to
the sale and/or closing of the unprofitable practices. In 1996, margins
declined slightly compared to 1995 as a result of the JEH acquisition. JEH
derived a larger percent of its net sales from distribution as compared to the
Company, and its distribution operations had lower gross profit margins than
its patient-care services. Also causing the decline in margins in 1996 was a
decision by the management of the company not to eliminate any duplicative
expenses during the two months ended December 31, 1996 following the JEH
acquisitions. Exclusive of the JEH acquisition, EBITDA margins increased in
1996 as compared to 1995. In 1997 margins were higher than 1996 primarily from
the integration of JEH and the elimination of duplicative expenses. The EBITDA
margin in 1998 increased compared to 1997 as a result of consummating
acquisitions of O&P patient-care centers with historical EBITDA margins of
approximately 20%. The following sets forth the Company's EBITDA and operating
margins during each of the past five years:
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
EBITDA margin (1) 11.1% 16.1% 15.0% 15.8% 16.7%
Operating margin 5.2% 11.1% 10.7% 12.6% 13.7%
<FN>
(1) "EBITDA" is defined as income from continuing operations before
depreciation and amortization. EBITDA is not a measure of performance
under Generally Accepted Accounting Principles ("GAAP"). While EBITDA
should not be considered in isolation or as a substitute for net income,
cash flows from operating activities and other income or cash flow
statement data prepared in accordance with GAAP, or as a measure of
profitability or liquidity, management understands that EBITDA is
customarily used as a criteria in evaluating heath care companies.
Moreover, substantially all of the Company's financing agreements
contain covenants in which EBITDA is used as a measure of financial
performance. EBITDA margin is defined as EBITDA as a percent of net
sales.
</FN>
</TABLE>
SEASONALITY
The Company's results of operations are affected by seasonal
considerations. The adverse weather conditions often experienced in certain
geographical areas of the United States during the first quarter of each year,
together with a greater degree of patients' sole responsibility for their
insurance deductible payment obligations during the beginning of each calendar
year, have contributed to lower Company net sales during that quarter.
24
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain items
of the Company's statements of operations as a percentage of the Company's net
sales:
<TABLE>
<CAPTION>
For the Years Ended December 31,
---------------------------------------
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Net sales 100.0% 100.0% 100.0%
Cost of products and services sold 48.2 50.5 49.5
Gross profit 51.8 49.5 50.5
Selling, general and administrative 36.7 33.7 33.8
Depreciation and amortization 3.0 2.0 1.8
Acquisition and integration costs 3.7 --- ---
Amortization of excess cost over net
assets acquired 1.2 1.2 1.3
Income from operations 7.0 12.6 13.7
Interest expense, net 3.8 3.4 1.0
Income before taxes and extraordinary item 3.0 9.0 12.5
Income taxes 1.3 3.8 5.1
Net income 1.5 3.4 7.4
</TABLE>
YEARS ENDED DECEMBER 31, 1998 AND 1997
NET SALES. Net sales for the year ended December 31, 1998 were
approximately $187.9 million, an increase of approximately $42.3 million, or
29.1%, over net sales of approximately $145.6 million for the year ended
December 31, 1997. The increase was primarily a result of: (i) acquisitions
during 1998, and (ii) an 11.1% increase in net sales attributable to
patient-care centers and facilities operating during both periods.
GROSS PROFIT. Gross profit in 1998 was approximately $95.0 million, or
31.9%, over the prior year. The cost of products and services sold for the
year ended December 31, 1998, was $92.9 million compared to $73.5 million in
1997. Gross profit as a percentage of net sales for patient-care service was
55% and 54% in the years ended December 31, 1997 and 1998. Gross profit as a
percentage of net sales for manufacturing and distribution was 45% and 18% for
1998 compared to 45% and 16% for 1997, respectively. The total Company gross
profit as a percent of net sales increased from 49.5% in 1997 to 50.5% in
1998. The 1% increase in the Company's gross profit as a percentage of net
sales is primarily attributable to the increase in the percentage of net sales
from patient-care services from 77% to 81%.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses in 1998 increased approximately $14.4 million, or 29.3%, compared to
1997. The increase in selling, general and administrative expenses was
primarily a result of the acquisition of O&P patient-care centers. Selling,
general and administrative expenses as a percent of net sales increased to
33.8% in 1998 from 33.7% in 1997.
INCOME FROM OPERATIONS. Principally as a result of the above, income
from operations in 1998 totaled approximately $25.7 million, an increase of
$7.4 million, or 40.4%, over the prior year. Income from operations as a
25
<PAGE>
percentage of net sales increased to 13.7% in 1998 from 12.6% in 1997.
INTEREST EXPENSE. Interest expense for the year ended December 31, 1998
was approximately $1.9 million, a decrease of approximately $3.0 million, or
61.2%, from the approximately $4.9 million of interest expense incurred during
1997. Interest expense as a percent of net sales decreased to 1.0% in 1998
from 3.4% for 1997. The decrease in interest expense was primarily
attributable to the repayment of bank debt out of the proceeds of the public
equity offering in the third quarter of 1998.
INCOME TAXES. The Company's effective tax rate was 41% in 1998 versus
42% in 1997. The decrease in 1998 is a result of the disproportionate impact
of the amortization of the excess costs over net assets acquired in relation
to taxable income in 1997.
EXTRAORDINARY ITEM. A pre-tax extraordinary item of $4.6 million ($2.7
million, net of tax benefit) in 1997, represents entirely a write-off of debt
issue costs and debt discount as a result of extinguishing approximately $58.3
million of bank debt from the net proceeds of the 1997 public equity offering.
NET INCOME. As a result of the above, the Company recorded income before
extraordinary item of $13.8 million for the year ended December 31, 1998,
compared to $7.6 million for the prior year. A pre-tax extraordinary item of
$4.6 million ($2.7 million, net of tax benefit) on early extinguishment of
debt was recognized in 1997 in connection with refinancing of bank
indebtedness. No extraordinary item was recognized in 1998.
As a result of the above, the company reported net income of $13.8
million, or $.75 per common dilutive share, for the year ended December 31,
1998, as compared to net income of $4.9 million, or $.37 per common dilutive
share, for the year ended December 31, 1997.
YEARS ENDED DECEMBER 31, 1997 AND 1996
NET SALES. Net sales for the year ended December 31, 1997 were
approximately $145.6 million, an increase of approximately $78.8 million, or
118%, over net sales of approximately $66.8 million for the year ended
December 31, 1996. The increase was primarily a result of: (i) the acquisition
of J.E. Hanger, Inc. of Georgia ("JEH") on November 1, 1996, as well as other
acquisitions during 1997, and (ii) an 11.7% increase in net sales attributable
to patient-care centers and facilities operating during both periods.
GROSS PROFIT. Gross profit in 1997 was approximately $37.5 million, or
108%, over the prior year. The cost of products and services sold for the year
ended December 31, 1997, was $73.5 million compared to $32.2 million in 1996.
Gross profit as a percentage of net sales for patient-care service was 55.1%
in the years ended December 31, 1996 and 1997. Gross profit as a percentage of
net sales for manufacturing and distribution was 44.9% and 16% for those
years, respectively. The total Company gross profit as a percent of net sales
declined from 51.8% in 1996 to 49.5% in 1997. The 2.3% decrease in the
Company's gross profit as a percentage of net sales is primarily attributable
26
<PAGE>
to the acquisition of JEH, which operated a large distribution division that
had lower gross profit margins than patient-care services.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses in 1997 increased approximately $24.5 million, or 99.9%, compared to
1996. The increase in selling, general and administrative expenses was
primarily a result of the acquisition of JEH and other acquisitions. Selling,
general and administrative expenses as a percent of net sales decreased to
33.7% in 1997 from 36.7% in 1996. The selling, general and administrative
expenses as a percentage of net sales decreased primarily as a result of cost
cutting measures completed during the fourth quarter of 1996 and the first six
months of 1997.
INCOME FROM OPERATIONS. Principally as a result of the above, income
from operations in 1997 totaled approximately $18.3 million, an increase of
$13.6 million, or 290.0%, over the prior year. Income from operations as a
percentage of net sales increased to 12.6% in 1997 from 7.0% in 1996.
INTEREST EXPENSE. Interest expense for the year ended December 31, 1997
was approximately $4.9 million, an increase of approximately $2.4 million, or
93.6%, over the approximately $2.5 million of interest expense incurred during
1996. Interest expense as a percent of net sales decreased to 3.4% in 1997
from 3.8% for 1996. The increase in interest expense was primarily
attributable to the increase in bank debt resulting from the acquisition of
JEH in November 1996, which was offset in part by the repayment of bank debt
out of the proceeds of the public equity offering in the third quarter of
1997.
INCOME TAXES. The Company's effective tax rate was 42% in 1997 versus
45% in 1996. The decrease in 1997 is a result of the disproportionate impact
of the amortization of the excess costs over net assets acquired in relation
to taxable income in 1996.
EXTRAORDINARY ITEM. A pre-tax extraordinary item of $4.6 million ($2.7
million, net of tax benefit) in 1997, represents entirely a write-off of debt
issue costs and debt discount as a result of extinguishing approximately $58.3
million of bank debt from the net proceeds of the third quarter public equity
offering.
NET INCOME. As a result of the above, the Company recorded income from
operations before extraordinary item of $7.6 million for the year ended
December 31, 1997, compared to $1.1 million for the prior year. A pre-tax
extraordinary item of $4.6 million ($2.7 million, net of tax benefit) on early
extinguishment of debt was recognized in 1997 compared to $139,000 ($83,000,
net of tax benefit) in 1996. Both extraordinary items were in connection with
refinancings of bank indebtedness.
As a result of the above, the company reported net income of $4.9
million, or $.37 per common dilutive share, for the year ended December 31,
1997, as compared to net income of $998,000, or $.11 per common dilutive
share, for the year ended December 31, 1996.
27
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's consolidated working capital at December 31, 1998 was
approximately $49.7 million and cash and cash equivalents available were
approximately $9.7 million.
At December 31, 1997, the Company had a credit agreement (the "Credit
Agreement") with a syndicate of banks, (collectively, the "Banks") that
provided 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"). During 1998, the Company paid off
all indebtedness incurred under the Credit Agreement and had no indebtedness
thereunder at December 31, 1998. The Credit Agreement currently provides for
the $25,000,000 Acquisition Loan Commitment and $8,000,000 Revolving Loan
Commitment.
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 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 1.75% depending upon
the ratio of the Company's total indebtedness to annual earnings before
interest, taxes, depreciation and amortization. At December 31, 1998, the
Company's interest rate would have been 6%.
On July 29, 1998, 3,300,000 shares of common stock of the Company were
sold in an underwritten public offering at $17.00 per share. Of that amount,
2,400,000 shares were sold by the Company and 900,000 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 repay the
amounts of the A-Term Loan, B-Term Loan, Acquisition Loan and Revolving Loan
outstanding at that time. The underwriters did not exercise the over allotment
option to purchase up to 495,000 additional shares of common stock.
The Company's total debt at December 31, 1998, including a current
portion of approximately $4.4 million, was approximately $15.6 million. Such
indebtedness was entirely related to subordinated seller notes issued in
connection with various acquisitions.
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 1998, the Company acquired 17 O&P companies and one prosthetic
component manufacturing company. The aggregate purchase price, excluding
potential earn-out provisions, was $39.1 million, comprised of $28.8 million
in cash, $7.9 million in promissory notes and 141,417 shares of common stock
of the Company valued at $2.4 million. The cash portion of the purchase price
28
<PAGE>
of these acquisitions was borrowed under the Company's Revolving Loan and
Acquisition Loan.
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 or securities convertible into 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.
PROPOSED REDUCTION IN FEDERAL MEDICARE PROGRAM
In February 1999, the U.S. Health Care Financing Administration
announced proposed legislation that would reduce Medicare funding in the
Administration's proposed healthcare budget for the fiscal year ending
September 30, 2000. Approximately $580 million of the planned reduction is
proposed to be achieved over five years, of which approximately $70 million
would be in the first year, by limiting the reimbursement for O&P expenditures
to a national median level. Currently, there are ten regions in the country
and O&P pricing levels in those regions differ. The proposed cutback in
Medicare O&P reimbursement to the national median would most adversely effect
O&P service providers in the higher priced regions. The proposed legislation
has not been officially introduced and the Company can make no representation
at this time as to whether it will be introduced or implemented or as to
whether it would have a materially adverse effect on the Company.
NEW ACCOUNTING STANDARDS. In June 1998, the Financial Accounting
Standard Board issued Statement of Financial Accounting Standards (SFAS) 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.
OTHER. Inflation has not had a significant effect on the Company's
operations, as increased costs to the Company generally have been offset by
increased prices of products and services sold.
The Company primarily provides services and customized devices
throughout the United States and is reimbursed, in large part, by the
patients' third-party insurers or governmentally funded health insurance
programs. The ability of the Company's debtors to meet their obligations is
principally dependent upon the financial stability of the insurers of the
Company's patients and future legislation and regulatory actions.
29
<PAGE>
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
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, was
completed during the first quarter of 1999. 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 Year 2000 compliant, the software vendors have targeted
June 1999 as a completion date. Part (3), testing, started in the first
quarter of 1999 and is expected to be substantially finished at the end the
second quarter and to continue, as needed, into the new millennium.
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.
30
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
The Company has entered into an interest rate swap agreement to reduce
the impact of changes in interest rates on its Senior Financing Facilities. At
December 31, 1998, the Company had an outstanding interest rate swap agreement
with a commercial bank, having a total notional principal amount of up to
$26,950,000. However, at December 31, 1998, there were no borrowings
outstanding. The agreement effectively minimizes the Company's base interest
rate exposure between a floor of 5.32% and a cap of 7.0%. The interest rate
swap agreement matures on September 30, 1999. The Company is exposed to credit
loss in the event of non-performance by the other party to the interest rate
swap agreement. All other debt accrues interest at a fixed rate.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements and schedules required hereunder
and contained herein are listed under Item 14(a) below. The Company is not
subject to the requirement to file selected quarterly financial data under
Item 302 of Regulation S-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
31
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Pursuant to General Instruction G(3) of Form 10-K, the information
called for by this item regarding directors is hereby incorporated by
reference from the Company's definitive proxy statement or amendment hereto to
be filed pursuant to Regulation 14A not later than 120 days after the end of
the fiscal year covered by this report. Information regarding the Company's
executive officers is set forth under Item 4A of this Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION.
Pursuant to General Instruction G(3) of Form 10-K, the information
called for by this item is hereby incorporated by reference from the Company's
definitive proxy statement or amendment hereto to be filed pursuant to
Regulation 14A not later than 120 days after the end of the fiscal year
covered by this report.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Pursuant to General Instruction G(3) of Form 10-K, the information
called for by this item is hereby incorporated by reference from the Company's
definitive proxy statement or amendment hereto to be filed pursuant to
Regulation 14A not later than 120 days after the end of the fiscal year
covered by this report.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Pursuant to General Instruction G(3) of Form 10-K, the information
called for by this item is hereby incorporated by reference from the Company's
definitive proxy statement or amendment hereto to be filed pursuant to
Regulation 14A not later than 120 days after the end of the fiscal year
covered by this report.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON
FORM 8-K.
(a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE:
(1) FINANCIAL STATEMENTS:
HANGER ORTHOPEDIC GROUP, INC.
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1997
and 1998
32
<PAGE>
Consolidated Statements of Income for the years
ended December 31, 1996, 1997 and 1998
Consolidated Statements of Changes in Shareholders'
Equity for the years ended December
31, 1996, 1997 and 1998
Consolidated Statements of Cash Flows for the years
ended December 31, 1996, 1997 and 1998
Notes to Consolidated Financial Statements
(2) FINANCIAL STATEMENTS SCHEDULE:
Report of Independent Accountants
Schedule II - Valuation and qualifying accounts
All other schedules are omitted either because they are not applicable or
required, or because the required information is included in the financial
statements or notes thereto:
(b) REPORTS ON FORM 8-K:
No Forms 8-K were filed during the quarter ended
December 31, 1998.
(c) EXHIBITS: The following exhibits are filed herewith or
incorporated herein by reference:
Exhibit No. Document
----------- --------
3(a) Certificate of Incorporation, as amended, of the Registrant.
(Incorporated herein by reference to Exhibit 3.1 to the
Registrant's Annual Report on Form 10-K for the fiscal year
ended September 30, 1988.)
3(b) Certificate of Amendment of the Registrant's Certificate of
Incorporation (which, among other things, changed the
Registrant's corporate name from Sequel Corporation to
Hanger Orthopedic Group, Inc.), as filed on August 11, 1989
with the Office of the Secretary of State of Delaware.
(Incorporated herein by reference to Exhibit 3(b) to the
Registrant's Current Report on Form 10-K dated February 13,
1990.)
3(c) Certificate of Agreement of Merger of Sequel Corporation and
Delaware Sequel Corporation. (Incorporated herein by
reference to Exhibit 3.1(a) to the Registrant's Annual
Report on Form 10-K for the fiscal year ended September 30,
1988.)
33
<PAGE>
3(d) Certificate of Ownership and Merger of Hanger Acquisition
Corporation and J. E. Hanger, Inc. as filed with the Office
of the Secretary of the State of Delaware on April 11, 1989.
(Incorporated herein by reference to Exhibit 2(f) to the
Registrant's Current Report on Form 8-K dated May 15, 1989.)
3(e) Certificate of Designation, Preferences and Rights of
Preferred Stock of the Registrant as filed on February 12,
1990 with the Office of the Secretary of State of Delaware.
(Incorporated herein by reference to Exhibit 3(a) to the
Registrant's Current Report on Form 8-K dated February 13,
1990.)
3(f) By-Laws of the Registrant, as amended. (Incorporated herein by
reference to Exhibit 3 to the Registrant's Current Report on
Form 8-K dated May 15, 1989.)
10(a) Registration Agreement, dated May 15, 1989, between Sequel
Corporation, First Pennsylvania Bank, N.A., Gerald E.
Bisbee, Jr., Ivan R. Sabel, Richard A. Stein, Ronald J.
Manganiello, Joseph M. Cestaro and Chemical Venture Capital
Associates. (Incorporated herein by reference to Exhibit
10(l) to the Registrant's Current Report on Form 8-K dated
May 15, 1989.)
10(b) First Amendment dated as of February 12, 1990, to the
Registration Agreement, dated as of May 15, 1989, by and
among Hanger Orthopedic Group, Inc., First Pennsylvania
Bank, N.A., Ivan R. Sabel, Richard A. Stein, Ronald J.
Manganiello, Joseph M. Cestaro and Chemical Venture Capital
Associates. (Incorporated herein by reference to Exhibit
10(m) to the Registrant's Current Report on Form 8-K dated
February 13, 1990.)
10(c) Fifth Amendment, dated as of November 8, 1990, to the Stock
and Note Purchase Agreement, dated as of February 28, 1989
and as amended on May 9, 1989, May 15, 1989, February 12,
1990, and June 19, 1990 by and among J. E. Hanger, Inc., as
successor to Hanger Acquisition Corporation, Ronald J.
Manganiello, Joseph M. Cestaro, Chemical Venture Capital
Associates and Chemical Equity Associates. (Incorporated
herein by reference to Exhibit 10(f) to the Registrant's
Current Report on Form 8-K filed on November 21, 1990.)
10(d) Form of Stock Option Agreements, dated as of August 13, 1990,
between Hanger Orthopedic Group, Inc. and Thomas P. Cooper,
James G. Hellmuth, Walter F. Abendschein, Jr., Norman
Berger, Bruce B. Grynbaum and Joseph S. Torg. (Incorporated
herein by reference to Exhibit 10(rrr) to the Registrant's
Registration Statement on Form S-2, File No. 33-37594.) *
* Management contract or compensatory plan
34
<PAGE>
10(e) Employment and Non-Compete Agreement, dated as of May 16,
1994, between Hanger Orthopedic Group, Inc. and Ivan R.
Sabel. (Incorporated herein by reference to Exhibit 10 (xx)
of the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1994.) *
10(f) Employment and Non-Compete Agreement, dated as of May 16,
1994, between Hanger Orthopedic Group, Inc. and Richard A.
Stein. (Incorporated herein by reference to Exhibit 10 (yy)
of the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1994.) *
10(g) Agreement and Plan of Merger, dated as of July 29, 1996, among
Hanger Orthopedic Group, Inc., SEH Acquisition Corporation
and J.E. Hanger, Inc. of Georgia. (Incorporated herein by
reference to Exhibit 2 to the Registrant's Current Report on
Form 8-K filed on November 12, 1996.)
10(h) Credit Agreement, dated November 1, 1996, among Hanger
Orthopedic Group, Inc., various banks and Banque Paribas, as
agent. (Incorporated herein by reference to Exhibit 10(a) to
the Registrant's Current Report on Form 8-K filed on
November 12, 1996.)
10(i) Senior Subordinated Note Purchase Agreement, dated as of
November 1, 1996, among Hanger Orthopedic Group, Inc. and
the purchasers listed therein. (Incorporated hereby by
reference to Exhibit 10(b) to the Registrant's Current
Report on Form 8-K filed on November 12, 1996.)
10(j) Warrants to purchase Common Stock of Hanger Orthopedic Group,
Inc. issued November 1, 1996. (Incorporated herein by
reference to Exhibit 10(c) to the Registrant's Current
Report on Form 8-K filed on November 12, 1996.)
10(k) 1991 Stock Option Plan of the Registrant, as amended.
(Incorporated herein by reference to Exhibit 10 to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998.)*
10(l) 1993 Non-Employee Directors Stock Option Plan of the
Registrant. (Incorporated herein by reference to Exhibit
4(b) to the Registrant's Registration Statement on Form S-8
(File No. 33-63191).)*
10(m) Employment and Non-Compete Agreement, dated as of November 1,
1996, and Amendment No. 1 thereto, dated January 1, 1997,
between the Registrant and H.E. Thranhardt. (Incorporated
herein by reference to Exhibit 10(p) to the Registrant's
Annual Report on Form 10-K for the year ended December 31,
1997.)
* Management contract or compensatory plan
35
<PAGE>
10(n) Employment and Non-Compete Agreement, dated as of November 1,
1996, between the Registrant and John McNeill. (Incorporated
herein by reference to Exhibit 10(q) to the Registrant's
Annual Report on Form 10-K for the year ended December 31,
1997.)
10(o) Asset Purchase Agreement, dated as of March 26, 1997, by and
between Hanger Prosthetics & Orthotics, Inc., Acor
Orthopaedic, Inc., and Jeff Alaimo, Greg Alaimo and Mead
Alaimo. (Incorporated by reference to Exhibit 2 to the
Current Report on Form 8-K filed by the Registrant on April
15, 1997.)
10(p) Asset purchase Agreement, dated as of May 8, 1997, by and
between Hanger Prosthetics & Orthotics, Inc., Fort Walton
Orthopedic, Inc., Mobile Limb and Brace, Inc. and Frank
Deckert, Ronald Deckert, Thomas Deckert, Robert Deckert and
Charles Lee. (Incorporated by reference to Exhibit 2 to the
Current Report on Form 8-K filed by the Registrant on June
5, 1997.)
10(q) Second Amendment, dated June 25, 1997, to Credit Agreement,
dated November 1, 1996, among Hanger Orthopedic Group, Inc.,
various banks and Banque Paribas, as agent. (Incorporated
herein by reference to Exhibit 10(r) to the Registrant's
Registration Statement on Form S-2 (File No. 333-30193).)
10(r) Asset Purchase Agreement, dated as of November 3, 1997, by and
between Hanger Prosthetics & Orthotics, Inc., Morgan
Prosthetic-Orthotics, Inc. and Dan Morgan. (Incorporated
herein by reference to Exhibit 10(v) to the Registrant's
Annual Report on Form 10-K for the year ended December 31,
1997.)
10(s) Asset Purchase Agreement, dated as of December 23, 1997, by
and between Hanger Prosthetics & Orthotics, Inc.,
Harshberger Prosthetic & Orthotic Center, Inc., Harshberger
Prosthetic & Orthotic Center of Mobile, Inc., Harshberger
Prosthetic & Orthotic Center of Florence, Inc., FAB-CAM,
Inc. and Jerald J. Harshberger. (Incorporated herein by
reference to Exhibit 10(w) to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1997.)
21 List of Subsidiaries of the Registrant. (Incorporated herein
by reference to Exhibit 21 to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1997.)
24 Consent of PricewaterhouseCoopers L.L.P.
27 Financial Data Schedule for the year ended December 31, 1998
* Management contract or compensatory plan
36
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
HANGER ORTHOPEDIC GROUP, INC.
Dated: March 18, 1999 By: /s/IVAN R. SABEL, CPO
---------------------
Ivan R. Sabel, CPO
Chief Executive Officer
(Principal Executive Officer)
Dated: March 18, 1999 By: /s/RICHARD A. STEIN
-------------------
Richard A. Stein
Vice President - Finance
Principal Financial and
Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons, on behalf of the
Registrant and in the capacities and on the dates indicated.
Dated: March 18, 1999 /s/IVAN R. SABEL, CPO
---------------------
Ivan R. Sabel, CPO
Chief Executive Officer
and Director (Principal
Executive Officer)
Dated: March 18, 1999 /s/RICHARD A. STEIN
-------------------
Richard A. Stein
Vice President - Finance,
Treasurer and Secretary
(Principal Financial and
Accounting Officer)
Dated: March 18, 1999 /s/MITCHELL J. BLUTT, M.D.
--------------------------
Mitchell J. Blutt, M.D.
Director
37
<PAGE>
Dated: March 18, 1999 /s/EDMOND E. CHARRETTE, M.D.
----------------------------
Edmond E. Charrette, M.D.
Director
Dated: March 18, 1999 /s/THOMAS P. COOPER, M.D.
-------------------------
Thomas P. Cooper, M.D.
Director
Dated: March 18, 1999 /s/ROBERT J. GLASER, M.D.
-------------------------
Robert J. Glaser, M.D.
Director
Dated: March 18, 1999 /s/JAMES G. HELLMUTH
--------------------
James G. Hellmuth
Director
Dated: March 18, 1999 /s/RISA J. LAVIZZO-MOUREY, M.D.
-------------------------------
Risa J. Lavizzo-Mourey, M.D.
Dated: March 18, 1999 /s/WILLIAM L. MCCULLOCH
-----------------------
William L. McCulloch
Director
Dated: March 18, 1999 /s/H.E. THRANHARDT, CPO
-----------------------
H.E. Thranhardt, CPO
Director
38
<PAGE>
INDEX TO FINANCIAL STATEMENTS
HANGER ORTHOPEDIC GROUP, INC.
Report of Independent Accountants F-1
Consolidated balance sheets as of December 31, 1997
and 1998 F-2
Consolidated statements of income for the years
ended December 31, 1996, 1997 and 1998 F-4
Consolidated statements of changes in shareholders'
equity for the years ended December 31, 1996,
1997 and 1998 F-5
Consolidated statements of cash flows for the years
ended December 31, 1996, 1997 and 1998 F-6
Notes to Consolidated Financial Statements F-7
FINANCIAL STATEMENT SCHEDULE
Report of Independent Accountants S-1
Schedule II - Valuation and Qualifying Accounts S-2
39
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Hanger Orthopedic Group, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, changes in shareholders' equity and cash
flows present fairly, in all material respects, the financial position of
Hanger Orthopedic Group, Inc. and Subsidiaries at December 31, 1998 and 1997,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion expressed above.
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
March 2, 1999
F-1
<PAGE>
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-------------------------------------
1997 1998
-------------- --------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 6,557,409 $ 9,682,786
Accounts receivable, less allowances for doubtful accounts
of $4,871,000 and $8,022,000 in 1997 and
1998, respectively 31,145,327 39,156,940
Inventories 17,445,476 16,934,600
Prepaid and other assets 4,260,656 4,063,648
Deferred income taxes 2,127,185 4,497,724
-------------- --------------
Total current assets 61,536,053 74,335,698
-------------- --------------
PROPERTY, PLANT AND EQUIPMENT
Land 4,269,045 4,267,045
Buildings 8,326,732 8,522,978
Machinery and equipment 7,591,821 13,008,780
Furniture and fixtures 2,378,808 2,980,647
Leasehold improvements 3,142,244 4,263,274
-------------- --------------
25,708,650 33,042,724
Less accumulated depreciation and amortization 7,538,385 10,333,371
-------------- --------------
18,170,265 22,709,353
-------------- --------------
INTANGIBLE ASSETS
Excess cost over net assets acquired 81,150,328 114,074,842
Non-compete agreements 2,236,979 1,724,440
Other intangible assets 3,221,912 2,701,639
-------------- --------------
86,609,219 118,500,921
Less accumulated amortization 9,101,531 10,545,148
-------------- --------------
77,507,688 107,955,773
-------------- --------------
OTHER ASSETS
Other 768,604 947,297
-------------- --------------
TOTAL ASSETS $ 157,982,610 $ 205,948,121
============== ==============
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
F-2
<PAGE>
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-------------------------------------
1997 1998
-------------- --------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt $ 5,747,865 $ 4,407,369
Accounts payable 3,827,338 4,975,581
Accrued expenses 3,597,104 4,635,048
Customer deposits 1,145,001 1,122,438
Accrued compensation related cost 8,037,805 9,000,721
Deferred revenue 150,418 516,943
-------------- --------------
Total current liabilities 22,505,531 24,658,100
-------------- --------------
Long-term debt 23,237,321 11,154,116
Deferred income taxes 3,405,833 5,222,766
Other liabilities 2,210,445 2,360,219
Mandatorily redeemable preferred stock class C, 300 shares authorized,
liquidation preference of $500 per share (See Note M) 303,753 ---
Mandatorily redeemable preferred stock class F, 100,000 shares authorized,
liquidation preference of $1,000 per share (See Note M) --- ---
Commitments and contingent liabilities (See Note J)
SHAREHOLDERS' EQUITY
Common stock, $.01 par value; 25,000,000 shares authorized, 15,670,100 and
18,825,372 shares issued and 15,536,605 and
18,691,877 shares outstanding in 1997 and 1998, respectively 156,702 188,255
Additional paid-in capital 102,585,837 144,970,114
Retained earnings 4,232,750 18,050,113
-------------- --------------
106,975,289 163,208,482
Treasury stock, cost -- (133,495 shares) (655,562) (655,562)
-------------- --------------
106,319,727 162,552,920
-------------- --------------
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $ 157,982,610 $ 205,948,121
============== ==============
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
F-3
<PAGE>
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31,
<TABLE>
<CAPTION>
1996 1997 1998
-------------- -------------- --------------
<S> <C> <C> <C>
Net sales $ 66,805,944 $ 145,597,876 $ 187,870,312
Cost of products and services sold 32,233,373 73,533,398 92,903,145
-------------- -------------- --------------
Gross profit 34,572,571 72,064,478 94,967,167
Selling, general and administrative 24,549,802 49,075,956 63,512,051
Depreciation and amortization 2,016,390 2,870,539 3,293,490
Amortization of excess cost over net assets acquired 832,075 1,810,283 2,488,264
Acquisition costs 1,297,819 --- ---
Integration costs 1,181,694 --- ---
-------------- -------------- --------------
Income from operations 4,694,791 18,307,700 25,673,362
Interest expense, net (2,546,561) (4,932,385) (1,902,315)
Other expense, net (177,216) (209,296) (315,337)
-------------- -------------- --------------
Income before taxes and extraordinary item 1,971,014 13,166,019 23,455,710
Provision for income taxes 889,886 5,526,000 9,616,000
-------------- -------------- --------------
Income before extraordinary item 1,081,128 7,640,019 13,839,710
Extraordinary loss on early extinguishment of debt, net of tax benefit (83,234) (2,693,791) ---
-------------- -------------- --------------
Net income $ 997,894 $ 4,946,228 $ 13,839,710
============== ============== ==============
Income before extraordinary item applicable to common stock $ 1,057,313 $ 7,613,967 $ 13,817,363
============== ============== ==============
Basic Per Common Share Data
- --------------------------------------
Income before extraordinary item $0.12 $0.65 $0.82
Extraordinary item, net of tax benefit (0.01) (0.23) ---
-------------- -------------- --------------
Net income $0.11 $0.42 $0.82
============== ============== ==============
Shares used to compute basic per common share amounts 8,469,645 11,792,892 16,812,717
Diluted Per Common Share Data
- --------------------------------------
Income before extraordinary item $0.12 $0.58 $0.75
Extraordinary item, net of tax benefit (0.01) (0.21) ---
-------------- -------------- --------------
Net income $0.11 $0.37 $0.75
============== ============== ==============
Shares used to compute diluted per common share amounts 8,663,161 13,138,377 18,515,567
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
F-4
<PAGE>
HANGER ORTHOPEDIC GROUP, INC
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the Years Ended December 31, 1996, 1997 and 1998
<TABLE>
<CAPTION>
Retained
Additional Earnings
Common Common Paid in (Accumulated Treasury
Shares Stock Capital Deficit) Stock Total
---------- -------- ------------- ----------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 8,290,544 $ 84,241 $ 33,574,058 $(1,711,372) ($655,562) $ 31,291,365
Preferred dividends declared (23,815) (23,815)
Net Income 997,894 997,894
Issuance of Common Stock in
connection with the exercise
of stock options 13,758 138 46,733 46,871
Issuance of Common Stock in
connection with the exercise
of stock warrants 11,332 113 (113) ---
Issuance of Common Stock in
connection with the purchase
of JEH 1,000,000 10,000 5,240,000 5,250,000
Issuance of Warrants in
connection with the purchase
of JEH 133,000 133,000
Issuance of Warrants in
connection with the Senior
Subordinated Note Agreement 2,038,500 2,038,500
---------- -------- ------------- ----------- ---------- -------------
Balance, December 31, 1996 9,315,634 94,492 41,008,363 (713,478) (655,562) 39,733,815
---------- -------- ------------- ----------- ---------- -------------
Preferred dividends declared (26,052) (26,052)
Net Income 4,946,228 4,946,228
Issuance of Common Stock in
connection with the exercise
of stock options 395,277 3,953 2,823,194 2,827,147
Issuance of Common Stock in
connection with the exercise
of stock warrants 11,694 117 (117) ---
Issuance of Common Stock in
connection with the purchase
of Fort Walton Mobile 64,000 640 499,360 500,000
Issuance of Common Stock in
Public Offering 5,750,000 57,500 58,281,089 58,338,589
---------- -------- ------------- ----------- ---------- -------------
Balance, December 31, 1997 15,536,605 156,702 102,585,837 4,232,750 (655,562) 106,319,727
---------- -------- ------------- ----------- ---------- -------------
Preferred dividends declared (22,347) (22,347)
Net Income 13,839,710 13,839,710
Issuance of Common Stock in
connection with the exercise
of stock options 338,069 3,381 2,252,406 2,255,787
Issuance of Common Stock in
connection with the exercise
of stock warrants 275,786 2,758 (2,758) ---
Issuance of Common Stock in
connection with acquisitions 141,417 1,414 2,398,586 2,400,000
Issuance of Common Stock in
Public Offering 2,400,000 24,000 37,736,043 37,760,043
---------- -------- ------------- ----------- ---------- -------------
Balance, December 31, 1998 18,691,877 $188,255 $144,970,114 $18,050,113 ($655,562) $162,552,920
========== ======== ============= =========== ========== =============
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
F-5
<PAGE>
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31,
<TABLE>
<CAPTION>
1996 1997 1998
-------------- -------------- --------------
<S> <C> <C> <C>
Cash flow from operating activities:
Net income $ 997,894 $ 4,946,228 $ 13,839,710
Adjustments to reconcile net income to net cash provided by
Operating activities:
Provision for bad debt 1,629,065 5,613,076 7,510,240
Provision for inventory reserves --- 1,160,000 2,201,718
Depreciation and amortization 2,016,390 2,870,539 3,293,490
Amortization of excess cost over net assets acquired 832,075 1,810,283 2,488,264
Amortization of debt discount 42,469 152,065 ---
Deferred taxes (684,119) 2,060,301 (553,606)
Extraordinary loss on early extinguishment of debt 138,724 4,644,491 ---
Changes in assets and liabilities, net of effects from acquired companies:
Accounts receivable (2,772,619) (9,380,532) (10,772,516)
Inventories 737,104 (1,068,769) 255,758
Prepaid and other assets (199,638) (2,586,738) 610,979
Other assets 27,342 176,083 (87,001)
Accounts payable 361,441 (1,326,067) (586,476)
Accrued expenses 709,638 (1,000,414) (212,170)
Accrued wages & payroll taxes 1,942,581 (400,575) 246,970
Customer deposits 88,461 576,240 (22,985)
Deferred revenue 126,411 (156,580) 168,635
Other liabilities (66,459) 22,167 149,776
-------------- -------------- --------------
Net cash provided by operating activities 5,926,760 8,111,798 18,530,786
-------------- -------------- --------------
Cash flow from investing activities:
Purchase of fixed assets (1,239,364) (2,581,424) (2,859,015)
Acquisitions, net of cash (37,671,754) (15,800,077) (30,332,704)
Purchase of patents (31,840) (88,671) (59,815)
Purchase of non-compete agreements (200,000) (255,650) (398,790)
Decrease in other intangibles (7,596) --- ---
-------------- -------------- --------------
Net cash used in investing activities (39,150,554) (18,725,822) (33,650,324)
-------------- -------------- --------------
Cash flow from financing activities:
Net repayments under revolving credit agreement (12,700,000) --- ---
Repayment of preferred stock --- --- (326,100)
Proceeds from issuance of Common Stock 46,871 61,165,736 40,015,830
Proceeds from long-term debt 65,000,000 8,256,000 6,000,000
Repayment of long-term debt (11,040,029) (58,781,418) (27,444,815)
Increase in financing costs (2,966,951) (41,287) ---
-------------- -------------- --------------
Net cash provided by financing activities 38,339,891 10,599,031 18,244,915
-------------- -------------- --------------
Increase (decrease) in cash and cash equivalents 5,116,097 (14,993) 3,125,377
Cash and cash equivalents at beginning of year 1,456,305 6,572,402 6,557,409
-------------- -------------- --------------
Cash and cash equivalents at end of year $ 6,572,402 $ 6,557,409 $ 9,682,786
============== ============== ==============
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
F-6
<PAGE>
HANGER ORTHOPEDIC GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - THE COMPANY
Hanger Orthopedic Group, Inc. is one of the nation's largest professional
practice management companies in the O&P rehabilitation industry. In addition
to providing O&P patient-care services through its operating subsidiaries, the
Company also manufactures and distributes components and finished patient-care
products to the O&P industry primarily in the United States. Hanger's largest
subsidiary, Hanger Prosthetics & Orthotics, Inc. formerly known as J.E.
Hanger, Inc., was founded in 1861 by a Civil War amputee and is the oldest
company in the O&P industry in the United States. Orthotics is the design,
fabrication, fitting and supervised use of custom-made braces and other
devices that provide external support to treat musculoskeletal disorders.
Prosthetics is the design, fabrication and fitting of custom-made artificial
limbs.
NOTE B - SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries. All
intercompany transactions and balances have been eliminated.
USE OF ESTIMATES: The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS: The Company considers all highly liquid
investments with original maturities of three months or less at the date of
purchase to be cash equivalents. At various times throughout the year, the
Company maintains cash balances in excess of FDIC limits.
FAIR VALUE OF FINANCIAL INSTRUMENTS: The carrying value of the Company's
short-term financial instruments, such as receivables and payables approximate
their fair values, based on the short-term maturities of these instruments.
The carrying value of the Company's long-term debt approximates fair value
based on using rates currently available to the Company for debt with similar
terms and remaining maturities.
INVENTORIES: Inventories, which consist principally of purchased parts,
are stated at the lower of cost or market using the first-in, first-out (FIFO)
method.
COMPUTER SOFTWARE: During 1998, the Company adopted Statement of Position
("SOP") No. 98-1, "Accounting for the costs of Computer Software Developed or
Obtained for Internal Use." The adoption of this statement did not have a
material effect on the Company's financial position or results of operations.
F-7
<PAGE>
LONG-LIVED ASSET IMPAIRMENT: The Company reviews its long-lived assets
for impairment whenever events or changes in circumstances indicate that the
carrying amount of the assets may not be recoverable through future cash
flows. If it is determined that an impairment loss has occurred based on
expected cash flows, then the loss is recognized in the income statement.
PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment are recorded
at cost. The cost and related accumulated depreciation of assets sold, retired
or otherwise disposed of are removed from the respective accounts, and any
resulting gains or losses are included in the statement of income.
Depreciation is computed for financial reporting purposes using the
straight-line method over the estimated useful lives of the related assets as
follows: machinery and equipment and furniture and fixtures - 5 years;
leasehold improvements - term of lease; and buildings - 10-20 years.
Depreciation expense was approximately $1,288,000, $2,173,000 and $2,806,000
for the years ended December 31, 1996, 1997 and 1998, respectively.
INTANGIBLE ASSETS: Non-compete agreements are recorded based on
agreements entered into by the Company and are amortized over their estimated
useful lives ranging from 5 to 7 years using the straight-line method. Other
intangible assets are recorded at cost and are amortized over their estimated
useful lives of up to 16 years using the straight-line method. Excess cost
over net assets acquired represents the excess of purchase price over the
value assigned to net identifiable assets of purchased businesses and is
amortized using the straight-line method over 40 years.
REVENUE RECOGNITION: Revenue on the sale of orthotic and prosthetic
devices is recorded when the device is accepted by the patient. Revenues from
referral service contracts is recognized over the term of the contract.
Deferred revenue represents billings made prior to the final fitting and
acceptance by the patient and unearned service contract revenue. Revenue is
recorded at its net realizable value taking into consideration all
governmental and contractual discounts.
CREDIT RISK: The Company primarily provides services and customized
devices throughout the United States and is reimbursed by the patients'
third-party insurers or governmentally funded health insurance programs. The
Company performs ongoing credit evaluations of its distribution customers.
Accounts receivable are not collateralized. The ability of the Company's
debtors to meet their obligations is dependent upon the financial stability of
the insurers of the Company's customers and future legislation and regulatory
actions. Additionally, the Company maintains reserves for potential losses
from these receivables that historically have been within management's
expectations.
INCOME TAXES: Income taxes are determined in accordance with Statement of
Financial Accounting Standards ("SFAS") 109, which requires recognition of
deferred income tax liabilities and assets for the expected future tax
consequences of events that have been included in the financial statements or
tax returns. Under this method, deferred income tax liabilities and assets are
determined based on the difference between financial statement and tax bases
of assets and liabilities using enacted tax rates in effect for the year in
which the differences are expected to reverse. SFAS 109 also provides for the
recognition of deferred tax assets if it is more likely than not that the
assets will be realized in future years.
F-8
<PAGE>
STOCK-BASED COMPENSATION: Compensation costs attributable to stock option
and similar plans are recognized based on any difference between the quoted
market price of the stock on the date of the grant over the amount the
employee is required to pay to acquire the stock (the intrinsic value method
under Accounting Principles Board Opinion 25). SFAS 123, "Accounting for
Stock-Based Compensation," requires companies electing to continue to use the
intrinsic value method to make pro forma disclosures of net income and
earnings per share as if the fair value based method of accounting had been
applied. The Company has adopted the disclosure only provisions of SFAS 123.
COMPREHENSIVE INCOME: Effective January 1, 1998 the Company adopted the
provisions of SFAS 130, "Reporting Comprehensive Income." SFAS 130 establishes
standards for reporting and display of comprehensive income and its components
in the financial statements. The adoption of SFAS 130 had no effect on the
Company's consolidated financial statements.
SEGMENT INFORMATION: In 1998, the Company adopted SFAS 131, "Disclosures
about Segments of an Enterprise and Related Information". SFAS 131 supersedes
SFAS 14, "Financing Reporting for Segments of a Business Enterprise",
replacing the "industry segment" approach with the "management" approach. The
management approach designates the internal organization that is used by
management for making operating decisions and assessing performance as the
source of the Company's reportable segments. SFAS 131 also requires disclosure
about products and services, geographic areas and major customers. The
adoption of SFAS 131 did not affect the results of operations or financial
position of the company.
NEW ACCOUNTING STANDARDS: In June 1998, the Financial Accounting Standard
Board issued SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities," which is effective for fiscal years beginning after June 15,
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.
F-9
<PAGE>
NOTE C - SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION
The following are the supplemental disclosure requirements for the
statements of cash flows:
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Cash paid during the period for:
Interest $ 2,273,629 $ 5,361,176 $ 2,099,051
Income taxes 1,893,990 2,469,000 8,307,000
Non-cash financing and investing activities:
Preferred dividends declared 23,815 26,052 ---
Issuance of notes in connection with acquisition --- 8,314,200 7,934,457
Issuance of Common Stock in connection with acquisition 5,250,000 500,000 2,400,000
Issuance of warrants in connection with acquisition 133,000 --- ---
Issuance of warrants in connection with Senior Subordinated Notes 2,038,500 --- ---
Change in goodwill resulting from reduction in estimated acquisition costs --- 3,236,552 3,860,843
</TABLE>
NOTE D - ACQUISITIONS
During 1996, the Company acquired one orthotic and prosthetic company,
J.E. Hanger, Inc. of Georgia ("JEH"), pursuant to the terms of a Merger
Agreement. As of the acquisition date, JEH, headquartered in Alpharetta,
Georgia, operated 94 patient-care centers and five warehouses located
primarily in the Mid-Atlantic and Southeastern United States. Under the terms
of the agreement, which became effective on November 1, 1996, the Company paid
JEH shareholders $44,000,000 in cash and issued 1,000,000 shares of Company
Common Stock and paid an additional $1,783,000 to the former JEH shareholders
on March 27, 1997 pursuant to provisions in the Merger Agreement calling for a
post-closing adjustment. In addition the Company issued warrants for 35,000
shares to one JEH noteholder in order to facilitate assumption of this debt
under the same terms and conditions that had existed prior to the acquisition.
During 1997, the Company acquired nine orthotic and prosthetic companies
and the remaining 20% interest of its majority owned subsidiary, Columbia
Brace. The aggregate purchase price, excluding potential earn-out provisions,
was $22,529,200, comprised of $13,715,000 in cash, $8,314,200 in promissory
notes and 64,000 shares of Common Stock of the Company valued at $500,000. The
notes are payable over two to five years with interest rates ranging from 6%
to 8%. The cash portion of the purchase price for these acquisitions was
borrowed under the Company's acquisition loan facility.
During 1998, the Company acquired seventeen orthotic and prosthetic
companies and one prosthetic component manufacturing company. The aggregate
purchase price, excluding potential earn-out provisions, was $39,125,180,
comprised of $28,790,723 in cash, $7,934,457 in promissory notes and 141,417
shares of common stock of the Company valued at $2,400,000. The notes are
payable over one to five years with interest rates ranging from 6.0000% to
7.6875%. The cash portion of the purchase price for these acquisitions was
borrowed under the Company's revolving and acquisition loan commitment.
F-10
<PAGE>
During 1998, the Company paid approximately $591,000 to the former owners
of ACOR Orthopaedic, Inc. - Retail Division and Montana Orthotics and
Prosthetics, Inc., pursuant to earnout provisions contained in the 1997
acquisition agreements. In addition, the Company paid approximately $1,528,000
to the former owners of Seattle Limb Systems, Inc., Fort Walton Orthopedic
Inc. and Mobile Limb and Brace, Inc., Morgan Prosthetics - Orthotics, Inc. and
Eugene Teufel & Sons, Inc., pursuant to working capital provisions contained
in the respective acquisition agreements. The Company has accounted for these
additional payments as additional purchase price resulting in an increase to
excess of cost over net assets acquired in the amount of $2,119,000.
Additional amounts aggregating approximately $2,890,000 may be paid over the
next five years in connection with earnout provisions contained in the 1998
acquisition agreements.
All of the above acquisitions have been accounted for as business
combinations in accordance with the purchase method. The results of operations
for these acquisitions are included in the Company's results of operations
from their date of acquisition. Excess cost over net assets acquired in these
acquisitions amounting to approximately $36,699,000, $20,451,000, and
$32,925,000 in 1996, 1997 and 1998, respectively, are amortized using the
straight-line method over 40 years.
The following table summarizes the unaudited consolidated pro forma
information, assuming the acquisitions had occurred at the beginning of each
of the following periods:
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Net sales $187,520,000 $207,073,000
Income before extraordinary item 9,789,000 15,674,000
Net income 7,095,000 15,674,000
Diluted income per common share before extraordinary item $.75 $.85
Diluted income per common share $.54 $.85
</TABLE>
The unaudited consolidated pro forma results do not necessarily represent
results which would have occurred if the acquisitions had taken place at the
beginning of each period, nor are they indicative of the results of future
combined operations.
F-11
<PAGE>
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 year. Diluted per common share
amounts are computed using the weighted average number of common shares
outstanding during the year and dilutive potential common shares. Dilutive
potential common shares consist of stock options, stock warrants and
convertible notes payable and are calculated using the treasury stock method.
Earnings per share are computed as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
1996 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Income before extraordinary item $ 1,081,128 $ 7,640,019 $ 13,839,710
Less preferred stock dividends declared (23,815) (26,052) (22,347)
------------- ------------- -------------
Income available to common stockholders used
to compute basic per common share amounts $ 1,057,313 $ 7,613,967 $ 13,817,363
============= ============= =============
Add back interest expense on convertible note
payable, net of tax --- --- $ 44,471
------------- ------------- -------------
Income available to common stockholders plus
assumed conversions used to compute diluted
per common share amounts $ 1,057,313 $ 7,613,967 $ 13,861,834
============= ============= =============
Shares of common stock
outstanding used to compute basic per
common share amounts 8,469,645 11,792,892 16,812,717
Effect of convertible note payable --- --- 87,501
Effect of dilutive options 163,442 556,476 836,126
Effect of dilutive warrants 30,074 789,009 779,223
Shares used to compute dilutive per ------------- ------------- -------------
common share amounts 8,663,161 13,138,377 18,515,567
============= ============= =============
Basic income per common share before
extraordinary item $ .12 $ .65 $ .82
Diluted income per common share before
extraordinary item $ .12 $ .58 $ .75
</TABLE>
Options to purchase 234,250 shares of common stock at prices ranging from
$17.38 per share to $22.50 per share were outstanding at December 31, 1998 but
were not included in the computation of diluted income per common share
because the options' exercise prices are greater than the average market price
of the common shares.
NOTE F - INVENTORY
Inventories at December 31, 1997 and 1998 consist of the following:
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Raw materials $ 7,685,134 $ 7,196,176
Work in-process 1,437,946 2,093,575
Finished goods 8,322,396 7,644,849
------------ ------------
$ 17,445,476 $ 16,934,600
============ ============
</TABLE>
F-12
<PAGE>
NOTE G- LONG-TERM DEBT
Long-term debt consists of the following at December 31, 1997 and 1998:
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
A-Term Loan Commitment $ 8,567,704 ---
B Term Loan Commitment 8,663,611 ---
Subordinated seller notes, non-collateralized net of unamortized discount
of $444,776 and $294,438 at December 31, 1997 and 1998, respectively,
with principal and interest payable in either monthly, quarterly or annual
installments at effective interest rates ranging from 6% to 11.572%,
maturing through January 2009. 11,256,699 $ 15,561,485
Other miscellaneous obligations with principal and interest payable in either
monthly or annual installments at interest rates ranging from 6% to 10%
maturing through December 2007. These obligations were repaid in 1998. 497,172 ---
------------ ------------
28,985,186 15,561,485
Less current portion 5,747,865 4,407,369
------------ ------------
$ 23,237,321 $ 11,154,116
============ ============
</TABLE>
At December 31, 1997, the Company had a $90,000,000 Credit Agreement
("Credit Agreement") with a syndication of banks which provided for a: (i) "A
Term Loan" in the principal amount of $29,000,000; (ii) "B Term Loan" in the
principal amount of $28,000,000; (iii) $25,000,000 Acquisition Loan Commitment
and; (iv) $8,000,000 Revolving Loan Commitment. At December 31, 1998, the
Company's Credit Agreement provides for the $25,000,000 Acquisition Loan
Commitment and $8,000,000 Revolving Loan Commitment.
The Company used the proceeds of the A-Term Loan, B-Term Loan and Senior
Subordinated Notes to finance the acquisition of JEH and to repay all amounts
then outstanding under the Company's former credit agreements. In connection
with this transaction, the Company recorded an extraordinary charge of
$138,724 ($83,234, net of tax benefit) for the write-off of unamortized
discounts and financing costs in 1996.
During August of 1997, the Company sold 5,750,000 shares of Common Stock
in a underwritten public offering at $11.00 per share resulting in
approximately $58.3 million of net proceeds to the Company. The Company
applied the net proceeds of the public offering to the repayment of certain
indebtedness, including Senior Subordinated Notes. Upon repayment of this debt
and the Credit Agreement being substantially modified, the Company incurred an
extraordinary loss of $4.6 million ($2.7 million net of tax benefit).
The modified Credit Agreement 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 $25,000,000 Acquisition Loan Commitment and the
$8,000,000 Revolving Loan Commitment bear base interest at the Company's
option of either LIBOR plus 2.50% or the Bank's prime rate plus 1.50%. The
F-13
<PAGE>
base interest rate is then reduced by .25% to 1.75% depending upon the ratio
of the Company's total indebtedness to annual earnings before interest, taxes,
depreciation and amortization. The Company's interest rate at December 31,
1998 would have been 6%. As of December 31, 1998 and 1997, the Company had no
outstanding balance on either the Acquisition or Revolving Loan Commitment.
The A-Term Loan is no longer available to the Company as of December 31, 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
was 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 is no longer available to the Company as of
December 31, 1998.
On July 29, 1998, 3,300,000 shares of common stock of the Company were
sold in an underwritten public offering at $17.00 per share. Of that amount,
2,400,000 shares were sold by the Company and 900,000 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 the A-Term Loan, B-Term Loan and other
indebtedness.
The Company has entered into an interest rate swap agreement to reduce
the impact of changes in interest rates on amounts outstanding on its Credit
Agreement. At December 31, 1997 and 1998, the Company had an outstanding
interest rate swap agreement with a commercial bank, having a total notional
principal amount of up to $26,950,000. However, at December 31, 1998, there
were no borrowings outstanding. The agreement effectively minimizes the
Company's base interest rate exposure between a floor of 5.32% and a cap of
7%. The interest rate swap agreement matures on September 30, 1999. The
Company is exposed to credit loss in the event of non-performance by the other
party to the interest rate swap agreement. However, the Company does not
anticipate non-performance by the counterparties.
Maturities of long-term debt at December 31, 1998 are as follows:
<TABLE>
<S> <C> <C>
1999 $ 4,407,369
2000 3,366,653
2001 3,150,334
2002 2,819,182
2003 1,586,699
Thereafter 231,248
--------------
$ 15,561,485
==============
</TABLE>
F-14
<PAGE>
NOTE H- INCOME TAXES
The provisions for income taxes for the years ended December 31, 1996,
1997 and 1998 consisted of the following:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Current:
Federal $ 1,146,564 $ 3,067,546 $ 8,683,364
State 427,441 398,153 1,486,242
------------ ------------ ------------
Total 1,574,005 3,465,699 10,169,606
Deferred:
Federal and State (684,119) 2,060,301 (553,606)
------------ ------------ ------------
Provision for income taxes on
income before extraordinary item 889,886 5,526,000 9,616,000
Tax benefit from extra-
ordinary item (55,489) (1,950,700) ---
------------ ------------ ------------
Provision for income taxes $ 834,397 $ 3,575,300 $ 9,616,000
============ ============ =============
</TABLE>
A reconciliation of the federal statutory tax rate to the effective tax
rate for the years ended December 31, 1996, 1997 and 1998 is as follows:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Federal statutory tax rate $ 670,145 $ 4,608,106 $ 8,209,498
Increase in taxes resulting from:
State income taxes (net of
federal effect) 98,573 606,397 984,778
Amortization of the excess cost
over net assets acquired 92,777 95,506 159,380
Other, net 28,391 215,991 262,344
------------ ------------ ------------
Provision for income taxes on
income before extraordinary item 889,886 5,526,000 9,616,000
Tax benefit from extraordinary
item (55,489) (1,950,700) ---
------------ ------------ ------------
Provision for income taxes $ 834,397 $ 3,575,300 $ 9,616,000
============ ============ ============
</TABLE>
F-15
<PAGE>
Temporary differences and carryforwards which give rise to deferred tax
assets and liabilities as of December 31, 1997 and 1998 are as follows:
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Deferred Tax Liabilities:
Book basis in excess of tax $ 798,657 $ 815,358
Depreciation and amortization 3,212,106 4,999,402
------------ ------------
4,010,763 5,814,760
------------ ------------
Deferred Tax Assets:
Net operating loss, Federal 276,272 224,122
Net operating loss, States 6,735 89,865
Accrued expenses 1,097,339 875,237
Reserve for bad debts 12,382 1,528,671
Inventory capitalization and reserves 1,069,421 2,093,815
Acquisition costs 269,966 278,008
------------ ------------
2,732,115 5,089,718
------------ ------------
Net deferred tax liabilities ($1,278,648) ($725,042)
============ ============
</TABLE>
For Federal tax purposes at December 31, 1998, the Company has available
approximately $640,000 of net operating loss carryforwards expiring from 1999
through 2007 and are subject to a limitation in their utilization of
approximately $149,000 per year as a result of several changes in shareholder
control.
NOTE I - DEFERRED COMPENSATION
In conjunction with the JEH acquisition, the Company assumed the unfunded
deferred compensation plan that had been established for certain key JEH
officers. The plan accrues benefits ratably over the period of active
employment from the time the contract is entered into to the time the
participant retires. Participation had been determined by JEH's Board of
Directors. The Company has purchased individual life insurance contracts with
respect to each employee covered by this plan. The Company is the owner and
beneficiary of the insurance contracts. The accrual related to the deferred
compensation arrangements amounted to approximately $2,099,000 and $2,248,000
at December 31, 1997 and 1998, respectively.
NOTE J - COMMITMENTS AND CONTINGENT LIABILITIES
The Company is engaged in legal proceedings in the normal course of
business. The Company believes that any unfavorable outcome from these suits
not covered by insurance would not have a material adverse effect on the
financial statements of the Company.
F-16
<PAGE>
NOTE K - OPERATING LEASES
The Company leases office space under noncancellable operating leases.
Future minimum rental payments, by year and in the aggregate, under operating
leases with terms of one year or more consist of the following at December 31,
1998:
<TABLE>
<S> <C> <C>
1999 $ 6,691,000
2000 5,680,000
2001 4,852,000
2002 3,187,000
2003 1,908,000
Thereafter 1,080,000
-------------
$ 23,398,000
</TABLE>
Rent expense was approximately $2,554,000, $4,509,000 and $6,283,000 for
the years ended December 31, 1996, 1997 and 1998, respectively.
NOTE L - PENSION AND PROFIT SHARING PLANS
Previously the Company had a separate defined contribution profit sharing
and 401(k) plan ("JEH Plan") covering all the employees of JEH, a wholly-owned
subsidiary of the Company acquired November 1, 1996. On this date, the Company
froze the JEH Plan such that no new employees of JEH were able to participate.
The Company did not incur any expense in connection with this plan during the
years ended December 31, 1996 and 1997. On January 1, 1998 the JEH Plan was
merged into the Company's 401(k) Savings and Retirement Plan.
The Company maintains a 401(k) Savings and Retirement plan to cover all
of the employees of the Company. The Company may make discretionary
contributions. Under this 401(k) plan, employees may defer such amounts of
their compensation up to the levels permitted by the Internal Revenue Service.
During 1998, the Company made a contribution of $583,410 to this plan. The
Company had not made any contributions to this plan in 1997 or 1996.
NOTE M - REDEEMABLE PREFERRED STOCKS
The Company has 10,000,000 authorized shares of preferred stock, par
value $.01 per share, which may be issued in various classes with different
characteristics.
At December 31, 1997, the Company had 300 shares of non-voting,
non-convertible Class C preferred stock issued and outstanding. The preferred
stock had an aggregate liquidation value equal to $150,000 plus accrued
dividends at 9% and was required to be redeemed on February 1, 2000. In
October 1998, the Company redeemed the preferred stock for $326,100, which
included the liquidation value plus accrued dividends to that date. There was
no Class C preferred stock issued or outstanding at December 31, 1998.
The 100,000 authorized shares of Class F preferred stock accrues
dividends cumulatively at 16.5% and was required to be redeemed prior to any
other class of preferred stock, before September 1998, for the aggregate
F-17
<PAGE>
liquidation value of $1,000 per share, plus accrued dividends. As of December
31, 1997 and 1998, none of the Class F preferred stock was issued or
outstanding.
NOTE N - WARRANTS AND OPTIONS
WARRANTS
In November 1990, the Company entered into a $2,450,000 Note which
required the Company, based on certain repayment provisions, to issue to an
affiliate in 1991 warrants to purchase 297,883 and 322,699 shares of common
stock at $4.16 and $7.65 per share, respectively. These warrants are
exercisable through December 31, 2001. In May 1996, warrants for 71,969 shares
were exercised at $4.16 per share which resulted in the issuance of 11,332
shares. In May 1997, warrants for 77,964 shares were exercised at $7.65 per
share which resulted in the issuance of 11,694 shares.
In November 1996, the Company issued warrants for 1,600,000 shares of
common stock to the holders of certain notes. In August 1997, the Company
repaid these notes with the proceeds from a public offering. In accordance
with the note agreement, warrants for 880,000 shares were terminated. The
remaining warrants for 720,000 shares provide that the noteholders may
purchase 418,365 shares and 301,635 shares for $4.01 and $6.375, respectively.
The warrants are exercisable through November 1, 2004. In November 1998,
150,818 warrants were exercised at $6.375 per share which resulted in the
issuance of 105,837 shares. Also, in November 1998, warrants for 209,183
shares were exercised at $4.01 per share which resulted in the issuance of
169,949 shares.
In November 1996, the Company issued warrants for 35,000 shares of common
stock as an incentive to one JEH noteholder to allow the notes to be assumed
by the Company under the same terms and conditions that had existed prior to
the acquisition. In January 1997, the noteholder exercised the warrants and
purchased 35,000 shares of common stock for $2.44 per share.
At December 31, 1998, warrants to purchase 830,648 shares at prices
ranging from $4.01 to $7.65 per share were outstanding.
OPTIONS
Under the Company's 1991 Stock Option Plan ("SOP"), 3,000,000 shares of
Common Stock are authorized for issuance under options that may be granted to
employees. The number of shares available for grant at December 31, 1998 was
679,751. There were no shares available for grant at December 31, 1997. Under
the SOP, options may be granted at an exercise price not less than the fair
market value of the Common Stock on the date of grant. Vesting and expiration
periods are established by the Compensation Committee of the Board of
Directors and generally vest three years following grant and generally expire
eight to ten years after grant.
Under the Company's 1993 Non-Employee Director Stock Option Plan, 250,000
shares of Common Stock are authorized for issuance to directors of the Company
who are not employed by the Company or any affiliate of the Company. Under
this plan, an option to purchase 5,000 shares of Common Stock is granted
automatically on an annual basis to each eligible director on the third
F-18
<PAGE>
business day following the date of each Annual Meeting of Stockholders of the
Company at which the eligible director is elected. The exercise price of each
option is equal to 100% of the fair market value of the Common Stock on the
date of grant. Each option vests at the rate of 25% each year for the first
four years after the date of grant of the option and each such option expires
ten years from the date of grant; provided, however, that in the event of
termination of a director's service other than by reason of total and
permanent disability or death, then the outstanding options of such holder
expire three months after such termination. Outstanding options remain
exercisable for one year after termination of service by reason of total and
permanent disability or death. The number of shares that remain available for
grant at December 31, 1997 and 1998 were 95,000 and 60,000, respectively.
In addition to the SOP, non-qualified options may be granted with
exercise prices that are less than the current market value. Accordingly,
compensation expense for the difference between current market value and
exercise price is recorded at the date of grant.
The following is a summary of option transactions and exercise prices:
<TABLE>
<CAPTION>
Stock Option Plan Non-Employee Director Stock Option Plan
----------------------------------------- -------------------------------------------
Price Weighted Price Weighted
Shares Per Share Average Shares Per Share Average
------ --------- -------- ------ --------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
December 31 1995 533,501 $2.75 to $12.25 5.49 167,500 $3.00 to $12.00 6.81
========== ========
Granted 802,250 $3.50 to $6.125 5.54 30,000 $5.875 5.875
Terminated (22,961) $2.81 to $12.25 4.93 ---
Exercised (7,508) $2.81 2.81 (6,250) $3.00 to $12.00 4.75
---------- --------
Outstanding at
December 31, 1996 1,305,282 $2.75 to $12.25 5.54 191,250 $3.00 to $12.00 6.74
========== ========
Granted 675,000 $6.00 to $13.25 9.95 35,000 $8.75 8.75
Terminated (34,984) $2.81 to $13.25 6.69 ---
Expired --- (6,250) $7.12 7.12
Exercised (388,915) $2.75 to $12.25 5.78 (19,375) $3.00 to $6.52 4.91
---------- --------
Outstanding at
December 31, 1997 1,556,383 $2.75 to $13.25 7.42 200,625 $3.00 to $12.00 7.27
========== ========
Granted 258,750 $13.31 to $22.50 19.78 35,000 $18.63 18.63
Terminated (57,424) $4.13 to $17.38 10.32 (9,000) $3.00 to $8.75 6.28
Exercised (302,476) $2.75 to $12.25 5.68 (57,750) $4.38 to $12.00 11.05
---------- --------
Outstanding at
December 31, 1998 1,455,233 $2.75 to $22.50 9.88 168,875 $3.00 to $18.63 8.38
========== ========
Vested at December 31,
1998 466,828 93,875
========== ========
</TABLE>
The Company applies APB Opinion 25 "Accounting for Stock Issued to
Employees", and related Interpretations in accounting for its plans.
Historically, the Company granted stock options at exercise prices equal to
the fair market value of the stock on the date of grant for fixed stock
options. Accordingly, no compensation cost has been recognized for its fixed
stock option plans. Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value at the grant dates
F-19
<PAGE>
for awards under those plans consistent with the method set forth in SFAS 123,
"Accounting for Stock-Based Compensations," the Company's net income and
earnings per share would have been reduced to the unaudited pro forma amounts
indicated below:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Net Income: As reported $997,894 $4,946,228 $13,839,710
Pro Forma 745,714 4,010,102 12,433,046
Diluted Income Per
Common Share: As reported $.11 $.37 $.75
Pro Forma $.08 $.31 $.67
</TABLE>
The following is a summary of stock options exercisable at December 31,
1996, 1997 and 1998, and their respective weighted-average exercise prices:
<TABLE>
<CAPTION>
Weighted-average
Number of Shares Exercise Price
---------------- ----------------
<S> <C> <C>
Options exercisable December 31, 1996 525,282 $6.45
Options exercisable December 31, 1997 442,972 5.66
Options exercisable December 31, 1998 560,703 7.02
</TABLE>
The pro forma information regarding net income and earnings per share is
required by SFAS 123, and has been determined as if the Company had accounted
for its employee stock options under the fair value method set forth in SFAS
123. The fair value for these options was estimated at the date of grant using
a Black-Scholes option pricing model with the following weighted average
assumptions for 1996, 1997 and 1998:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Expected term 7 5 5
Volatility factor 120% 58% 59%
Risk free interest rate 6.7% 6.3% 5.1%
Dividend yield 0 % 0 % 0 %
Fair value $5.03 $4.99 $10.87
</TABLE>
F-20
<PAGE>
The following table summarizes information concerning outstanding and
exercisable options as of December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------- -------------------------------------
Range of Exercise Number of Options Weighted Average Number of Options Weighted Average
Prices and Awards Remaining Exercise Price and Awards Exercise Price
Life (Years)
-------------------- ----------------- ------------ -------------- ----------------- ----------------
<S> <C> <C> <C> <C> <C>
$ 2.750 to $ 3.500 140,098 6.77 $ 3.16 65,098 $ 3.00
$ 4.125 to $ 4.125 52,261 7.22 $ 4.13 27,984 $ 4.13
$ 4.375 to $ 6.000 178,468 6.67 $ 5.81 106,751 $ 5.70
$ 6.125 to $ 6.125 494,656 7.89 $ 6.13 206,314 $ 6.13
$ 6.250 to $ 6.250 5,000 4.70 $ 6.25 5,000 $ 6.25
$ 6.520 to $ 8.750 36,875 8.30 $ 8.68 11,041 $ 8.59
$11.313 to $ 12.500 335,750 8.75 $11.35 113,515 $11.42
$13.250 to $ 13.875 143,000 8.86 $13.34 25,000 $13.25
$16.813 to $ 18.625 74,000 9.48 $17.94 0 $ 0.00
$20.000 to $ 22.500 164,000 9.95 $22.28 0 $ 0.00
------------------- --------- ------ ------ ------- ------
$ 2.750 to $ 22.500 1,624,108 8.18 $ 9.71 560,703 $ 7.02
</TABLE>
NOTE O - SEGMENT AND RELATED INFORMATION
Using the guidelines set forth in SFAS NO. 131, "Disclosures about
Segments of an Enterprise and Related Information", the Company has identified
three reportable segments in which it operates based on the products and
services it provides. The Company evaluates segment performance and allocates
resources based on the segments' EBITDA. "EBITDA" is defined as income from
operations before depreciation and amortization. EBITDA is not a measure of
performance under Generally Accepted Accounting Principles ("GAAP"). While
EBITDA should not be considered in isolation or as a substitute for net
income, cash flows from operating activities and other income or cash flow
statement data prepared in accordance with GAAP, or as a measure of
profitability or liquidity, management understands that EBITDA is customarily
used as a criteria in evaluating heath care companies. Moreover, substantially
all of the Company's financing agreements contain covenants in which EBITDA is
used as a measure of financial performance. EBITDA is presented for each
reported segment before reclassifications between EBITDA and other income
(expense) made for external reporting purposes.
The reportable segments are: (i) practice management and patient-care
centers; (ii) manufacturing; and (iii) distribution. These are described
further below:
PRACTICE MANAGEMENT AND PATIENT-CARE CENTERS - This segment consists of the
Company's owned and operated O&P patient-care centers as well as OPNET. The
patient-care centers provide services to design and fit orthotic and
prosthetic devices to patients. These centers also instruct patients in the
use, care and maintenance of the devices. OPNET is a national managed care
agent for O&P services, and a patient referral clearing house.
F-21
<PAGE>
MANUFACTURING - This segment consists of the manufacture and fabrication of
O&P components and finished patient-care products for both the O&P industry
and the company's own patient-care practices.
DISTRIBUTION - This segment distributes orthotic and prosthetic products and
components to both the O&P industry and the company's own patient-care
practices.
The accounting policies of the segments are the same as those described in the
summary of "Significant Accounting Policies."
Summarized financial information concerning the Company's reportable segments
is shown in the following table. Intersegment sales mainly include sales of
O&P components from the manufacturing and distribution segments to the
practice management and patient-care centers segment and were made at prices
which approximate market values.
<TABLE>
<CAPTION>
PRACTICE
MANAGEMENT
AND PATIENT
CARE CENTERS MANUFACTURING DISTRIBUTION OTHER TOTAL
------------ ------------- ------------ ----- -----
<S> <C> <C> <C> <C> <C>
1998
- ----
Net Sales
Customers $152,276,143 $ 8,547,613 $ 27,046,556 --- $187,870,312
Intersegments --- 2,575,840 18,684,367 $(21,260,207) ---
EBITDA 32,351,445 432,619 4,173,822 (6,451,203) 30,506,683
Total assets 57,945,254 8,946,530 9,796,767 129,259,570 205,948,121
Capital Expenditures 1,698,241 576,268 232,217 352,289 2,859,015
1997
- ----
Net Sales
Customers $112,330,673 $ 7,697,830 $ 25,569,373 --- $145,597,876
Intersegments --- 1,452,176 14,026,165 $(15,478,341) ---
EBITDA 22,931,498 856,861 3,851,507 (5,152,800) 22,487,066
Total assets 46,618,968 8,826,072 106,628 102,430,942 157,982,610
Capital Expenditures 1,792,268 441,549 134,310 213,297 2,581,424
1996
- ----
Net Sales
Customers $ 52,526,434 $ 8,040,422 $ 6,239,088 --- $ 66,805,944
Intersegments --- 1,388,695 4,634,996 (6,023,691) ---
EBITDA 9,868,220 1,427,165 93,934 (3,967,152) 7,422,167
Total assets 84,581,187 3,495,608 322,646 46,541,986 134,941,427
Capital Expenditures 519,917 382,951 19,794 316,702 1,239,364
</TABLE>
F-22
<PAGE>
The following table reconciles each reportable segment's EBITDA to
consolidated income before income taxes and extraordinary item:
<TABLE>
<CAPTION>
PRACTICE
MANAGEMENT
AND PATIENT
CARE CENTERS MANUFACTURING DISTRIBUTION OTHER TOTAL
------------ ------------- ------------ ----- -----
<S> <C> <C> <C> <C> <C>
1998
- ----
EBITDA $ 32,351,445 $ 432,619 $ 4,173,822 $ (6,451,203) $ 30,506,683
Depreciation and
Amortization (4,321,019) (1,008,974) (269,736) (182,025) (5,781,754)
Interest expense, net (1,538,095) (48,289) 6,061 (321,992) (1,902,315)
Other income (expense) 508,173 (75,996) 474,885 (273,966) 633,096
------------- ------------- ------------- ------------- -------------
Income before taxes $ 27,000,504 $ (700,640) $ 4,385,032 $ (7,229,186) $ 23,455,710
============= ============= ============= ============= =============
1997
- ----
EBITDA $ 22,931,498 $ 856,861 $ 3,851,507 $ (5,152,800) $ 22,487,066
Depreciation and
Amortization (3,458,426) (726,009) (230,158) (266,229) (4,680,822)
Interest expense, net (3,199,945) (35,760) 4,635 (1,701,315) (4,932,385)
Other income (expense) 45,643 (78,499) 306,748 18,268 292,160
------------- ------------- ------------- ------------- -------------
Income before taxes $ 16,318,770 $ 16,593 $ 3,932,732 $ (7,102,076) $ 13,166,019
============= ============= ============= ============= =============
1996
- ----
EBITDA $ 9,868,220 $ 1,427,165 $ 93,934 $ (3,967,152) $ 7,422,167
Depreciation and
Amortization (1,715,904) (726,710) (100,780) (305,071) (2,848,465)
Interest expense, net (735,114) (57,127) 181 (1,754,501) (2,546,561)
Other income (expense) (66,339) (46,229) 39,563 16,878 (56,127)
------------- ------------- ------------- ------------- -------------
Income before taxes $ 7,350,863 $ 597,099 $ 32,898 $ (6,009,846) $ 1,971,014
============= ============= ============= ============= =============
</TABLE>
The following table presents the details of "Other" EBITDA for the years ended
December 31:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Corporate general and administrative expenses $ 3,708,874 $ 5,098,781 $ 6,399,273
Other 258,278 54,019 51,930
--------------- --------------- ----------------
$ 3,967,152 $ 5,152,800 $ 6,451,203
============= ============= ==============
</TABLE>
F-23
<PAGE>
The following table presents the details of "Other" total assets at December
31:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Corporate intercompany receivable from
Practice Management and Patient-Care
Centers segment $ 27,997,143 $ 76,783,030 $ 93,712,942
Corporate intercompany receivable from
Manufacturing segment 11,274,588 5,385,807 20,216,624
Corporate intercompany receivable from
Distribution segment 1,874,314 15,003,494 3,788,192
Other 5,395,941 5,258,611 11,541,812
------------ ------------ ------------
$ 46,541,986 $102,430,942 $129,259,570
============ ============ ============
</TABLE>
"Other" total assets presented in the preceding table primarily consist of
corporate cash and deferred taxes not specifically identifiable to the
reportable segments.
The Company's foreign and export sales and assets located outside of the
United States are not significant. Additionally, no single customer accounted
for more than 10% of revenues in 1996, 1997 or 1998.
NOTE P - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Summarized unaudited quarterly financial data for the years ended
December 31, 1997 and 1998 are:
<TABLE>
<CAPTION>
Quarter Ended
------------------------------------------------------------
1998 March 31 June 30 September 30 December 31
- ---- -------- ------- ------------ -----------
<S> <C> <C> <C> <C>
Net Sales $40,750,018 $46,899,890 $48,776,505 $51,443,899
Gross Profit 19,446,887 23,638,848 24,798,718 27,082,714
Net income 1,695,426 3,618,204 4,119,954 4,406,126
DILUTED PER COMMON SHARE DATA
Net income .10 .21 .22 .22
1997
- ----
Net Sales $30,949,614 $36,644,645 $38,839,333 $39,164,284
Gross Profit 14,719,685 18,322,523 19,059,477 19,962,793
Income before extraordinary item 617,915 1,851,934 2,239,417 2,930,753
Extraordinary loss on early extinguishment
of debt, net of tax benefit --- --- (2,693,791) ---
Net income (loss) 617,915 1,851,934 (454,374) 2,930,753
DILUTED PER COMMON SHARE DATA
Income before extraordinary item .06 .18 .15 .17
Extraordinary item, net of tax benefit --- --- (.18) ---
Net income (loss) .06 .18 (.03) .17
</TABLE>
F-24
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
of Hanger Orthopedic Group, Inc.:
Our audits of the consolidated financial statements referred to in our
report dated March 2, 1999 appearing on page F-1 of the 1998 Annual Report to
Shareholders of Hanger Orthopedic Group, Inc. also included an audit of the
financial statement schedule listed in Item 14(a)(2) of this Form 10-K. In our
opinion, this financial statement schedule presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
March 2, 1999
S-1
<PAGE>
HANGER ORTHOPEDIC GROUP, INC.
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
ADDITIONS
BALANCE AT CHARGED TO IMPACT OF BALANCE AT
BEGINNING COSTS AND ACQUIRED END OF
YEAR CLASSIFICATION OF YEAR EXPENSES COMPANIES DEDUCTIONS YEAR
---- -------------- ---------- ----------- --------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
1998 Allowance for
doubtful accounts $4,871,000 $7,510,000 $1,125,000 $5,484,000 $8,022,000
Inventory Reserves $1,500,000 $2,202,000 $1,147,000 $4,849,000
1997 Allowance for
doubtful accounts $2,479,000 $5,613,000 $ 531,000 $3,752,000 $4,871,000
Inventory Reserves $1,160,000 $ 340,000 $1,500,000
1996 Allowance for
doubtful accounts $1,144,000 $1,629,000 $1,220,000 $1,514,000 $2,479,000
</TABLE>
<PAGE>
Consent of Independent Accountants
We consent to the incorporation by reference in the Registration Statement of
Hanger Orthopedic Group, Inc. and Subsidiaries on Form S-8 (File No. 33-63191)
of our reports dated March 2, 1999, on our audits of the consolidated
financial statements and financial statement schedule of Hanger Orthopedic
Group, Inc. and Subsidiaries as of December 31, 1998 and 1997 and for each of
the three years in the period ended December 31, 1998, which are included in
the Form 10-K.
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
March 22, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000722723
<NAME> HANGER ORTHOPEDIC GROUP, INC.
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 9,685,786
<SECURITIES> 0
<RECEIVABLES> 39,156,940
<ALLOWANCES> 8,022,000
<INVENTORY> 16,934,600
<CURRENT-ASSETS> 74,335,698
<PP&E> 33,042,724
<DEPRECIATION> 10,333,371
<TOTAL-ASSETS> 205,948,121
<CURRENT-LIABILITIES> 24,658,100
<BONDS> 11,154,116
0
0
<COMMON> 188,255
<OTHER-SE> 162,364,665
<TOTAL-LIABILITY-AND-EQUITY> 205,948,121
<SALES> 187,870,312
<TOTAL-REVENUES> 187,870,312
<CGS> 92,903,145
<TOTAL-COSTS> 69,293,805
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,902,315
<INCOME-PRETAX> 23,455,710
<INCOME-TAX> 9,616,000
<INCOME-CONTINUING> 13,839,710
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,839,710
<EPS-PRIMARY> 0.82
<EPS-DILUTED> 0.75
</TABLE>
