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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the fiscal year ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from to .
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Commission File Number 1-10670
HANGER ORTHOPEDIC GROUP, INC.
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(Exact name of registrant as specified in its charter.)
Delaware 84-0904275
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Two Bethesda Metro Center (Suite 1200), Bethesda, MD 20814
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(Address of principal executive offices) (Zip Code)
Registrant's phone number, including area code: (301) 986-0701
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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
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The aggregate market value of the registrant's Common Stock, par value
$.01 per share, held as of March 27, 2000 by non-affiliates of the registrant
was $106,638,587 based on the $6.0625 closing sale price of the Common Stock on
the New York Stock Exchange on such date.
As of March 27, 2000, the registrant had 18,910,002 shares of its
Common Stock issued and outstanding.
Indicate by check mark if disclosure of delinquent filers pursuant to
item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
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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
We develop, acquire and operate orthotic and prosthetic patient-care
centers. Our O&P centers are staffed by orthotists and prosthetists, who
design, fabricate, fit and supervise the use of external musculoskeletal
support devices and artificial limbs. As the country's only vertically
integrated O&P company, we also manufacture custom-made and prefabricated O&P
devices and are the country's largest distributor of O&P components and
finished O&P patient-care products.
Our products primarily are technologically advanced, custom devices
designed for adding functionality to patients' lives. We serve a clearly
identified patient need and provide tangible benefits to patients. Our industry
is characterized by stable, recurring revenues resulting from the need for
regular, periodic replacement or modification of O&P devices.
On July 1, 1999, we acquired NovaCare Orthotics & Prosthetics, Inc.
("NovaCare O&P"). As a result of that acquisition, we are the leading provider
of O&P patient-care services in the United States. NovaCare O&P was an active
acquirer of O&P businesses, having acquired over 90 O&P businesses from 1992
until we acquired it on July 1, 1999. At December 31, 1999, we had 617
patient-care centers and approximately 962 practitioners in 41 states and the
District of Columbia.
In November 1996, we acquired J.E. Hanger, Inc. of Georgia, an O&P
provider with 96 patient-care centers in 15 states and the largest O&P product
distribution business in the United States at that time. We successfully
integrated those operations, essentially doubling our number of patient-care
centers and certified practitioners and significantly expanding our
distribution capabilities.
Our acquisition of NovaCare O&P again more than doubled our number of
patient-care centers and certified O&P practitioners. The acquisition provided
national scope to our operations, expanding coverage into 11 additional states,
including Illinois, Missouri, Oklahoma and Iowa, and increasing our presence in
key existing markets, including California, New York, Arizona, Florida, Texas
and Pennsylvania.
COMPETITIVE STRENGTHS
We believe that the following competitive strengths will enable us to
continue to increase revenues, EBITDA and market share by (i) providing
"one-stop shopping" to large, national payor organizations and other customers,
(ii) maximizing operating efficiencies and economies of scale, and (iii)
maintaining a superior platform for strategic acquisitions:
LEADING MARKET POSITION IN A FRAGMENTED INDUSTRY. We are the nation's
largest provider of O&P services, with approximately 20% market share, 962 O&P
practitioners and 617 O&P patient-care centers in 41 states and the District of
Columbia.
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VERTICALLY INTEGRATED PROVIDER. We are the only vertically integrated
provider of O&P services in the United States. Along with our patient-care
services operations, we also manufacture custom-made and prefabricated O&P
devices. Additionally, we are the nation's largest distributor of O&P
components and finished O&P patient-care products, which allows us to reduce
the materials costs of our patient-care centers and offer prompt delivery of
components and products.
BALANCED BUSINESS MIX. Our business is fairly evenly distributed in
terms of both service mix and payor mix. For the year ended December 31, 1999,
our consolidated orthotics, prosthetics, manufacturing and distribution
revenues made up approximately 37.4%, 51.2%, 3.0% and 8.4%, respectively, of
consolidated net sales. For the same period, our combined payor mix was
approximately 59.0% private pay, 41.0% Medicare, Medicaid and U.S. Veterans
Administration.
INNOVATIVE PRODUCTS AND STRONG BRAND EQUITY. We have earned a strong
reputation within the O&P industry for the development and use of innovative
technology. For example, our patented Charleston Bending Brace, Seattle Foot,
Ortho-Mold, Lenox Hill Knee Brace and prosthetic Sabolich Socket have increased
patient comfort and capability, and can significantly shorten the
rehabilitation process. The quality of our products and the success of our
technological advances have generated broad media coverage, enhancing our brand
equity among payors, patients and referring physicians.
ABILITY TO SUCCESSFULLY INTEGRATE ACQUISITIONS. Prior to our
acquisition of NovaCare O&P, we had acquired and integrated over 75 O&P
businesses since 1986, and NovaCare O&P had acquired and integrated over 90 O&P
businesses since 1992. We have demonstrated an ability to improve the operating
performance of integrated businesses, resulting in significantly increased
"same-store" net sales and operating margins.
EXPERIENCED AND COMMITTED MANAGEMENT TEAM. We have a senior management
team with extensive experience in the O&P business. Ivan R. Sabel, our Chairman
of the Board, President and Chief Executive Officer, is a certified orthotist
and prosthetist, has worked in the O&P industry for 32 years, including 20
years as a practitioner. He has led our senior management team since 1995 and
has been a member of that team since 1986. We will continue to provide senior
management and O&P practitioners of Hanger Orthopedic Group with
performance-based bonuses, stock options and opportunities for corporate
advancement that will give them a significant financial interest in our
performance.
BUSINESS STRATEGY
Our objective is to build on our position as a full-service,
nationwide O&P company focused on the operation of O&P patient-care centers and
the manufacture and distribution of O&P products. The key elements of our
strategy for achieving this objective are to:
IMPLEMENT ACQUISITION-RELATED SYNERGIES. We believe we can reduce
costs and increase net sales by implementing acquisition-related synergies. We
expect that our operating margins will improve due to anticipated reductions in
administrative and personnel costs and also
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expect to reduce materials costs at NovaCare O&P's patient-care centers due to
increased purchases from Hanger Orthopedic Group. We will attempt to increase
"same-store" net sales by cross-selling Hanger Orthopedic Group and NovaCare
O&P products at our patient-care centers and using our expanded geographic
coverage to exploit national contracting opportunities. Our operating results
and financial condition should also benefit from enhanced capital availability
and other efficiencies resulting from our increased size.
INCREASE NUMBER OF O&P MANAGED CARE CONTRACTS. We intend to continue
to pursue O&P managed care contracts to increase market share and "same-store"
net sales growth. A national network of O&P patient-care centers will enable us
to negotiate for contracts with any local, regional or national third-party
payor seeking a single-source O&P provider.
EXPAND OUR O&P MANUFACTURING AND DISTRIBUTION OPERATIONS. Expansion of
our patient-care division, including as a result of the acquisition of NovaCare
O&P, will increase captive demand for our manufacturing and distribution
business. As the volume of our distribution increases, it will allow us to
achieve volume discounts in the cost of our distributed products. Our
manufacturing division should also benefit from increased net sales at the
distribution division by providing proprietary products to meet the increased
demand. Our manufacturing efforts will focus on the acquisition and/or
development of proprietary, patented products, such as our Lenox Hill knee
brace, Charleston Bending Brace, Seattle Foot, Ortho-Mold braces and prosthetic
Sabolich Socket.
ACQUIRE AND INTEGRATE O&P PRACTICES IN TARGETED GEOGRAPHICAL AREAS
ACROSS THE UNITED STATES. Our expansion program is focused on building on our
position as a national O&P patient-care network. When identifying patient-care
centers for acquisition, we seek to fill gaps strategically in our existing
geographic coverage. Typically, acquired practitioners sign multi-year
non-compete agreements, receive approximately 50% of acquisition consideration
in multi-year seller notes and can earn performance-based stock options and
bonuses.
DEVELOP NEW O&P PATIENT-CARE CENTERS IN EXISTING MARKETS. In addition
to acquiring patient-care centers, we intend to open new patient-care centers
in existing markets. We plan to pursue this strategy by opening satellite
centers in areas where a strong demand for O&P services has been identified. In
opening satellite patient-care centers, we minimize up-front investment by
utilizing professionals from a nearby existing center on a part-time basis to
test the viability of a full-time practice.
EXPAND AND IMPROVE OPERATIONS AT EXISTING AND ACQUIRED PATIENT-CARE
CENTERS. As we continue to add patient-care centers, we will be able to improve
margins by spreading administrative fixed costs and capital expenditures for
state-of-the-art equipment such as CAD/CAM systems. We can also enhance sales
by using brand-based marketing programs that are generally not available to
practitioners in smaller, independent practices.
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PATIENT-CARE CENTERS AND FACILITIES
As of December 31, 1999, we operated a total of 617 patient-care
centers, six distribution facilities and two manufacturing facilities,
substantially all of which are leased, as detailed in the following table:
<TABLE>
<CAPTION>
Jurisdiction Patent-Care Centers Distribution Facilities Manufacturing Facilities
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<S> <C> <C> <C>
Alabama.................................. 13 - -
Arizona.................................. 18 - -
Arkansas................................. 4 - -
California............................... 65 1 -
Colorado................................. 9 - -
Connecticut.............................. 15 - -
Delaware................................. 1 - -
District of Columbia..................... 2 - -
Florida.................................. 40 1 1
Georgia.................................. 24 1 -
Illinois................................. 26 1 -
Indiana.................................. 12 - -
Iowa..................................... 11 - -
Kansas................................... 13 - -
Kentucky................................. 10 - -
Louisiana................................ 9 - -
Maryland................................. 8 1 -
Massachusetts............................ 8 - -
Michigan................................. 8 - -
Minnesota................................ 11 - -
Mississippi.............................. 9 - -
Missouri................................. 17 - -
Montana.................................. 4 - -
Nebraska................................. 11 - -
Nevada................................... 5 - -
New Hampshire............................ 4 - -
New Jersey............................... 12 - -
New Mexico............................... 13 - -
New York................................. 32 - -
North Carolina........................... 13 - -
Ohio..................................... 27 - -
Oklahoma................................. 15 - -
Oregon................................... 17 - -
Pennsylvania............................. 38 - -
South Carolina........................... 12 - -
South Dakota............................. 2 - -
Tennessee................................ 18 - -
Texas.................................... 25 1 -
Virginia................................. 12 - -
West Virginia............................ 9 - -
Washington............................... 8 - 1
Wisconsin................................ 5 - -
Wyoming.................................. 2 - -
--
Total............................... 617 6 2
=== = =
</TABLE>
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.
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Prosthetics is the design, fabrication and fitting of custom-made artificial
limbs for patients who have lost limbs as a result of traumatic injuries,
vascular diseases, diabetes, cancer or congenital disorders.
Care of O&P patients is part of a continuum of rehabilitation services
from diagnosis to treatment and prevention of future injury. This continuum
involves the integration of several medical disciplines that begins with the
attending physician's diagnosis. Once a course of treatment is determined, the
physician, generally an orthopedic surgeon, vascular surgeon or physiatrist,
refers a patient to an O&P patient-care service provider for treatment. An O&P
practitioner then consults with both the referring physician and the patient to
formulate the prescription for and design of, an orthotic or prosthetic device
to meet the patient's needs.
We estimate that the patient-care O&P industry in the United States
represented approximately $1.9 billion in sales in 1997. Key trends expected to
increase demand for orthopedic rehabilitation services include the following:
GROWING ELDERLY POPULATION. The growth rate of the over-65 age
group is nearly triple that of the under-65 age group. With broader
medical insurance coverage, increasing disposable income, longer life
expectancy, greater mobility and improved technology and devices, the
elderly are expected to seek orthopedic rehabilitation services more
often.
COST-EFFECTIVE REDUCTION IN HOSPITALIZATION. As public and private
payors encourage reduced hospital admissions and reduced length of
stay, out-patient rehabilitation is in greater demand. O&P services
and devices have enabled patients to become ambulatory more quickly
after receiving medical treatment in the hospital. We believe that
significant cost savings can be achieved through the early use of O&P
services. The provision of O&P services in many cases reduces the need
for more expensive treatments, thus representing a cost savings to the
third-party payor.
GROWING PHYSICAL HEALTH CONSCIOUSNESS. There is a growing emphasis
on physical fitness, leisure sports and conditioning, such as running
and aerobics, which has led to increased injuries requiring orthopedic
rehabilitative services and products. In addition, as the current
middle-age population ages, it brings its more active life-style and
accompanying emphasis on physical fitness to the over-65 age group.
These trends are evidenced by the increasing demand for new devices
which provide support for injuries, prevent further or new injuries or
enhance physical performance.
ADVANCING TECHNOLOGY. The range and effectiveness of treatment
options have increased in connection with the technological
sophistication of O&P devices. Advances in design technology and
lighter, stronger and more cosmetically acceptable materials have
enabled the industry to produce new O&P products, which provide
greater comfort, protection and patient acceptability. Therefore,
treatment can be more effective and of shorter duration, contributing
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to greater mobility and a more active lifestyle for the patient. As a
result of advancing technology, orthotic devices have become more
prevalent and visible in many sports, including skiing, running and
tennis.
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 patient-care services market is highly fragmented and
relatively under-penetrated by multi-site operators. There are an estimated
3,300 certified prosthetists and/or orthotists and approximately 2,850 O&P
patient-care centers in the United States. We estimate that we account for
approximately 20% of total estimated O&P patient-care net sales. We do not
believe that any other competitor has a market share of more than 5% of total
estimated O&P patient-care net sales. We believe that the O&P industry will
continue to consolidate as a result of a variety of factors, including: (i)
increased pressures from growth in managed care; (ii) demonstrated benefits
from economies of scale; and (iii) desire by independent orthotists and
prosthetists to focus more on patient care and less on administration.
INCREASED MANAGED CARE PENETRATION. The expanding geographical reach
of the large managed care organizations makes it increasingly important for
them to contract for their patient-care needs with counterparts who have large,
national operations. Managed care companies therefore prefer to contract with a
single provider for all their O&P patient-care services. As a result, small
independent O&P practices feel pressure to consolidate in order to access
managed care referrals.
ECONOMIES OF SCALE. A significant portion of the cost of O&P services
is attributable to the cost of materials used in orthoses and prostheses.
Achieving purchase discounts through group purchasing can increase
profitability at each patient-care center. 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 businesses. Through consolidation,
individual providers are able to realize some financial liquidity while
enabling them to continue to provide patient-care services as employees of a
national O&P services provider.
PATIENT-CARE CENTER ADMINISTRATION
We provide all senior management, accounting, accounts payable,
payroll, sales and marketing, human resources and management information
systems services for our patient-care centers. By providing these services on a
centralized basis, we are able to provide such services
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to our patient-care centers and practitioners more efficiently and
cost-effectively than if such services had to be generated at each center. The
centralization of these services also permits our certified practitioners to
allocate a greater portion of their time to patient-care activities by reducing
the administrative responsibilities of operating the patient-care centers.
Billing and collections are handled on a decentralized basis, which we believe
enhances collectibility.
We also develop and implement programs designed to enhance the
efficiency of our clinical practices. Such programs include: (i) sales and
marketing initiatives to attract new-patient referrals by establishing
relationships with physicians, therapists, employers, managed care
organizations, hospitals, rehabilitation centers, out-patient clinics and
insurance companies; (ii) professional management and information systems to
improve efficiencies of administrative and operational functions; (iii)
professional-education programs for practitioners emphasizing new developments
in the increasingly sophisticated field of O&P clinical therapy; (iv) the
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 that is financially more difficult for
smaller, independent facilities to obtain.
We believe that the application of sales and marketing techniques is a
key element of our operational strategy. Due primarily to the fragmented nature
of the industry, the success of an O&P patient-care center has been largely a
function of its local reputation for quality of care, responsiveness and length
of service in the community. Individual practitioners have relied almost
exclusively on referrals from local physicians or physical therapists and
typically have not used marketing techniques.
PATIENT-CARE SERVICES
At December 31, 1999, we provided O&P patient-care services through
617 O&P patient-care centers and approximately 962 patient-care practitioners
in 41 states and the District of Columbia. The majority of our practitioners
are certified practitioners or candidates for formal certification by the O&P
industry certifying boards. Each of our patient-care centers is closely
supervised by one or more certified practitioners. The balance of our
patient-care practitioners are highly trained technical personnel who assist in
the provision of services to patients and fabricate various O&P devices.
A patient in need of O&P patient-care services is referred to one of
our patient-care centers upon a determination by the attending physician of a
course of treatment. One of our practitioners then consults with both the
referring physician and the patient to formulate the prescription for, and
design of, an orthotic or prosthetic device to meet the patient's needs.
The fitting process involves several stages in order to successfully
achieve desired functional and cosmetic results. The practitioner creates a
cast and takes detailed measurements of the patient to ensure an anatomically
correct fit. All of the prosthetic devices fit by our practitioners are custom
designed and fabricated by skilled practitioners who can balance fit, support
and comfort. Of the orthotic devices provided by us, a majority are custom
designed, fabricated and fit and the balance is prefabricated but custom fit.
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Custom devices are fabricated by our skilled technicians using the
castings, measurements and designs made by the practitioner. Technicians use
advanced materials and technologies to fabricate a custom device under quality
assurance guidelines. After final adjustments to the device by the
practitioner, the patient is instructed in the use, care and maintenance of the
device. A program of scheduled follow-up and maintenance visits is used to
provide post-fitting treatment, including adjustments or replacements as the
patient's physical condition and lifestyle change.
A substantial portion of our O&P services involves treatment of a
patient in a non-hospital setting, such as one of our patient-care centers, a
physician's office, an out-patient clinic or other facility. In addition, O&P
services are increasingly rendered to patients in hospitals, nursing homes,
rehabilitation centers and other alternate-site health care facilities. In a
hospital setting, the practitioner works with a physician to provide either
orthotic devices or temporary prosthetic devices that are later replaced by
permanent prostheses.
We also operate in-patient O&P patient-care centers at The Rusk
Institute of Rehabilitation Medicine at the New York University Medical Center
in New York, New York, the Harmarville Rehabilitation Center in Pittsburgh,
Pennsylvania and the Newington Children's Hospital in Newington, Connecticut.
OPNET
In 1995, we formed OPNET, a proprietary national preferred provider
O&P referral network serving managed care organizations, including HMOs and
PPOs. Through this network, managed care organizations can contract for O&P
services with any O&P patient-care center in the OPNET network. As of December
31, 1999, OPNET had a network of 738 patient-care centers (617 of which are
owned and operated by us) serving 618 managed care plans. We intend to continue
OPNET as a vehicle to achieve complete nationwide O&P patient-care coverage, to
increase market share and to increase "same-store" sales growth. 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.
MANUFACTURING AND DISTRIBUTION
In addition to on-site fabrication of custom O&P devices incidental to
the services rendered at its O&P patient-care centers, we manufacture O&P
components and finished patient-care products for both the O&P industry and our
own patient-care centers. We manufacture components and finished products under
various name brands such as Lenox Hill, CASH Brace, Ortho-Mold, Charleston
Bending Brace, DOBI-Symplex, Seattle Limb Systems and Sea Fab. The principal
products manufactured are prefabricated and custom-made spinal orthoses as well
as custom-made and off-the-shelf derotation knee braces. We distribute O&P
components and finished patient-care products to the O&P industry and to our
own patient-care practices. We inventory over 20,000 items, a majority of which
are manufactured by other companies and are distributed by us. During 1998, we
acquired Model and Instrument Development Corporation, a
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manufacturing facility located in Seattle, Washington which operated under the
trade name of Seattle Limb Systems and manufactured prosthetic and related
equipment.
The Sabolich Socket is a patented design that presently is only
available at our patient-care centers. A socket is the connecting point between
a prosthesis and the body of the patient. The Sabolich Socket is a highly
contoured flexible socket which has revolutionized both above-knee and
below-knee prosthetics. It features anatomically designed channels to
accommodate various muscle, bone, tendon, vascular and nerve areas. This unique
approach to socket design is generally accepted as superior to previous socket
systems.
Our distribution capability allows our personnel faster access to the
products needed to fabricate devices for patients. This is accomplished at
competitive prices, as a result of either manufacturing by us or direct
purchases by us from other manufacturers. As a result of faster access to
products, the length of a patient's treatment in the hospital can be reduced,
thereby contributing to health care cost containment.
Marketing of our manufactured products and distribution services is
conducted on a national basis, primarily through approximately 37 sales
representatives, catalogues and exhibits at industry and medical meetings and
conventions. We direct specialized catalogues to segments of the health care
industry, such as orthopedic surgeons and physical and occupational therapists.
In addition, we direct our broad-based marketing to the O&P industry and the
home health care industry.
To provide timely custom fabrication and service to its patients, we
employ technical personnel and maintain laboratories at each of its
patient-care centers. We use advanced computer-aided design and computer-aided
machinery ("CAD/CAM") technology to produce precise and uniform products. We
have several large, fully staffed central fabrication facilities to service its
patient-care centers. These strategically located facilities enable us to
fabricate those O&P products that are more easily produced in larger quantities
and in a more cost-effective manner, as well as serving as an auxiliary
production center for products normally fabricated at individual patient-care
centers.
We have earned a strong reputation within the O&P industry for the
development and use of innovative technology in our products which has
increased patient comfort and capability, and can significantly shorten the
rehabilitation process. The quality of our products and the success of our
technological advances have generated broad media coverage, enhancing our brand
equity among payors, patients and referring physicians.
As the only vertically integrated provider of O&P services in the
United States, we benefit from our ability to market and deliver O&P products
through its patient-care centers. As the patient-care division expands as a
result of our acquisition of NovaCare O&P, as well as continued future
expansion through the opening of additional satellite offices and additional
future acquisitions, it will heighten captive demand for our distribution
business. As the nation's largest distributor of O&P components and finished
O&P patient-care products, we will receive the profit margin associated with
O&P product manufacturing and distribution, reduce the materials cost of our
patient-care centers and offer prompt delivery of components and products.
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Our manufacturing division should also benefit from increased net sales at the
distribution division by providing proprietary products to meet the increased
demand. Our manufacturing efforts will focus on the acquisition and/or
development of proprietary patented products, such as our Lenox Hill knee
brace, Charleston Bending Brace, Seattle Foot, Ortho-Mold braces and prosthetic
Sabolich Socket. Furthermore, proprietary patented products, which were
previously available only at the patient-care centers of either Hanger
Orthopedic Group or NovaCare O&P, will, as a result of our acquisition of
NovaCare O&P, be hereafter marketed and sold throughout our national network of
patient-care centers.
RESEARCH & DEVELOPMENT
We will continue to engage actively in O&P product research and
development within our current cost parameters. Our manufacturing division
currently establishes an annual research and development budget in an amount
equal to less than ten percent of the net sales of the manufacturing division
for the prior year. This budgeted amount is then divided into two categories,
with approximately one-third of such amount being applied to improving existing
products manufactured by us and the remaining portion being applied to research
and development of new products. Improvements to existing products are made
through the use of newer and more advanced materials, as well as through
requests by existing purchasers of products who express their willingness to
purchase a greater number of such products if requested product improvements
are implemented. Thus, improvements to existing products are expected to
increase sales of such products, especially to those customers who requested
the product improvements.
Research and development of new products begins with numerous meetings
with patient-care practitioners and sales personnel in the O&P industry to
identify new product needs. Research and development expenditures for new
products are divided between two categories, with a majority of such
expenditures applied to new products which have a high probability of
successful sales with low technical risk and small development effort to
manufacture the product, and with the remaining amount applied to new products
which have higher technical risk and a higher risk of failure, but with higher
sales potential. Our manufacturing division then reviews the best use of its
budgeted funds and technical resources necessary to develop and manufacture all
new products in determining which new products will proceed to a product
development stage. Budgets are then developed for each new product project and
weekly reviews are conducted of the progress, time and cost of each project
throughout its development process. The economic viability of each potential
new product is tested during the first half of the product development process,
and we thereafter continue to pursue the development of those new products that
are expected to generate profitable sales.
ACQUISITIONS
From 1986 to June 1999, Hanger Orthopedic Group acquired over 75
businesses in 31 states and the District of Columbia. From 1992 to June 1999,
NovaCare O&P acquired over 90
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O&P businesses in 37 states. On July 1, 1999, Hanger Orthopedic Group acquired
NovaCare O&P. Subsequent to our acquisition of NovaCare O&P, we acquired one O&P
business.
We continue to be engaged in discussions with several O&P companies
relating to our possible acquisition of their patient-care centers. Our
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.
We consider 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
our operating model to the acquired company's patient-care centers. In
evaluating acquisitions in geographic areas where we have an established
presence, we target businesses that complement our existing network of
patient-care centers. In geographic areas where we have not yet established a
presence, we generally focus on acquiring strong regional businesses which have
multiple patient-care centers and experienced practitioners.
Our acquisition strategy also includes the retention and support of
the existing management of the acquired company, typically through the use of
employment contracts containing non-compete provisions generally for a duration
of two years after the date of termination of employment, and non-compete
agreements from sellers and key personnel generally for a duration of five
years from the date of closing of the acquisition, and incentive programs. In
addition, acquisition consideration typically consists of 50% cash and 50%
unsecured, subordinated promissory notes. Upon the completion of an
acquisition, we will integrate the business of the acquired company by: (i)
transferring all administrative and financial management responsibilities to
our corporate headquarters; (ii) providing all new personnel with compensation
and benefit packages and training by our Human Resources Department; and (iii)
providing the management of the acquired company with instruction on our latest
marketing and sales techniques. Thereafter, we will provide the management and
staff of the newly acquired company with financial incentives to induce greater
financial performance, with such financial incentives generally being in the
form of bonuses based upon the profitability of the office(s) in which such
employees perform services and the grant of performance-based stock options to
purchase shares of our common stock.
NEW-CENTER DEVELOPMENT
In addition to acquired patient-care centers, we develop 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
11
<PAGE> 14
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. We estimate that the cost of opening a
new satellite patient-care center is approximately $100,000, which includes
equipment, leasehold improvements and working capital. We expect a new
patient-care center to reach profitability, as measured by EBITDA, within six
months to one year of opening. No assurance can be given that we will be
successful in achieving these start-up and profitability goals with regard to
new patient-care centers.
REIMBURSEMENT SOURCES
The principal reimbursement sources for our O&P services are: (i)
private payor/third-party insurer sources which consist of individuals, private
insurance companies, HMOs, PPOs, hospitals, vocational rehabilitation, workers'
compensation and similar sources; (ii) Medicare, which is a federally funded
health-insurance program providing health insurance coverage for persons aged
65 or older and certain disabled persons; (iii) Medicaid, which is a
health-insurance program jointly funded by federal and state governments
providing health insurance coverage for certain persons in financial need,
regardless of age, and which may supplement Medicare benefits for financially
needy persons aged 65 or older; and (iv) the VA, with which Hanger has entered
into contracts to provide O&P services.
Medicare, Medicaid, the VA and certain state agencies, which accounted
for approximately 62.0%, 53.7% and 41.0% of our net sales in 1997, 1998 and
1999, respectively (based on a sampling of approximately 75%, 41% and 79% of
patient-care centers in 1997, 1998 and 1999, respectively), have set maximum
reimbursement levels for payments for O&P services and products. The health
care policies and programs of these agencies have been subject to changes in
payment 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.
We provide O&P services to eligible veterans pursuant to several
contracts with the VA. The VA establishes its reimbursement rates for itemized
products and services on a competitive bidding basis. The contracts, awarded on
a non-exclusive basis, establish the amount of reimbursement to the eligible
veteran if the veteran should choose to use our products and services. Hanger
Orthopedic Group has been awarded VA contracts in the past and expects that it
will obtain additional contracts when its present agreements expire.
COMPETITION
The competition among O&P patient-care centers is primarily for
referrals from physicians, therapists, employers, HMOs, PPOs, hospitals,
rehabilitation centers, out-patient clinics and insurance companies on both a
local and regional basis. We believe that distinguishing competitive factors in
the O&P industry are quality and timeliness of patient care
12
<PAGE> 15
and, to a lesser degree, charges for services. We compete with others in the
industry for trained personnel. To date, however, we have been able to achieve
our staffing needs and have experienced a relatively low turnover rate of
employees.
GOVERNMENT REGULATION
CERTIFICATION AND LICENSURE
Most states do not require separate licensure for O&P practitioners.
However, several states currently require O&P practitioners to be certified by
an organization such as the American Board for Certification.
The American Board for Certification conducts a certification program
for practitioners and an accreditation program for patient-care centers. The
minimum requirements for a certified practitioner are a college degree,
completion of an accredited academic program, one to four years of residency at
a patient-care center under the supervision of a certified practitioner and
successful completion of certain examinations. Minimum requirements for an
American Board for Certification-accredited patient-care center include the
presence of a certified practitioner and specific plant and equipment
requirements. While we endeavor to comply with all state licensure
requirements, no assurance can be given that we will be in compliance at all
times with these requirements.
We provide services under various contracts to federal agencies. These
contracts are subject to regulations governing federal contracts, including the
ability of the government to terminate for its convenience.
MEDICAL DEVICE REGULATION
We manufacture and distribute products that are subject to regulation
as medical devices by the Food and Drug Administration ("FDA") under the
Federal Food, Drug, and Cosmetic Act and accompanying regulations. We believe
that the products we manufacture and/or distribute, including O&P accessories
and components, are exempt from FDA's regulations for premarket clearance or
approval requirements and from requirements relating to good manufacturing
practices: (except for certain recordkeeping and complaint handling
requirements). We are required to adhere to regulations regarding adverse event
reporting, and are subject to inspection by the FDA for compliance with all
applicable requirements. Labeling and promotional materials also are subject to
scrutiny by the FDA and, in certain circumstances, by the Federal Trade
Commission. Although we have never been challenged by FDA for noncompliance
with FDA requirements, no assurance can be given that we would be found to be
or to have been in compliance at all times. Noncompliance could result in a
variety of civil and/or criminal enforcement actions, which could have a
material adverse effect on our business and results of operations.
13
<PAGE> 16
FRAUD AND ABUSE
We are subject to various federal and state laws pertaining to health
care 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 health care programs, including
Medicare, Medicaid, VA health programs and CHAMPUS. We have never been
challenged by a governmental authority under any of these laws and believe
that, based on this history, our operations are in material compliance with
such laws. However, because of the far-reaching nature of these laws, there can
be no assurance that one or more of our practices would not be required to
alter its practices as a result, or that the occurrence of one or more of these
events would not result in a material adverse effect on our business and
results of operations.
ANTIKICKBACK LAWS. Our operations are subject to federal and state
antikickback laws. The Federal Health Care Programs Antikickback Statute
(section 1128B(b) of the Social Security Act) prohibits persons or entities
from knowingly and willfully soliciting, offering, receiving, or paying any
remuneration in return for, or to induce, the referral of persons eligible for
benefits under a Federal Health Care Program (including Medicare, Medicaid, the
VA health programs and CHAMPUS), or the ordering, purchasing or leasing of
items or services that may be paid for, in whole or in part, by a Federal
Health Care Program. The statute may be violated when even one purpose (as
opposed to a primary or sole purpose) of a payment is to induce referrals or
other business. The regulations create a small number of "safe harbors."
Practices which meet all the criteria of an applicable safe harbor will not be
deemed to violate the statute; practices that do not satisfy all elements of a
safe harbor do not necessarily violate the statute, although such practices may
be subject to scrutiny by enforcement agencies. Several states also have
antikickback laws which vary in scope and may apply regardless of whether a
Federal Health Care Program is involved.
These laws may apply to certain of our operations. We have instituted
various types of discount programs for individuals or entities that purchase
its products and services. We also maintain financial relationships with
individuals and entities who may: (i) purchase our products and services; (ii)
refer patients to our O&P patient-care centers; or (iii) receive referrals
through OPNET. These relationships include, among other things, lease
arrangements with hospitals and OPNET participation arrangements. Because some
of these arrangements may not satisfy all elements of an applicable safe
harbor, they could be subject to scrutiny and challenge under one or more such
laws.
FALSE CLAIMS LAWS. We are also subject to federal and state laws
prohibiting individuals or entities from knowingly and willfully presenting, or
causing to be presented, claims for payment to third-party payors (including
Medicare and Medicaid) that are false or fraudulent or are for items or
services not provided as claimed. Each of our O&P patient-care centers is
responsible for preparation and submission of reimbursement claims to
third-party payors for items and services furnished to patients. In addition,
our personnel may, in some instances, provide advice on billing and
reimbursement for our products to purchasers. While we endeavors to ensure that
our billing practices comply with applicable laws, if claims submitted to
payors are
14
<PAGE> 17
deemed to be false, fraudulent, or for items or services not provided as
claimed, we could face liability for presenting or causing to be presented such
claims.
Physician Self-Referral Laws. We are also subject to federal and state
physician self-referral laws. With certain exceptions, the federal
Medicare/Medicaid physician self-referral law (the "Stark" law, section 1877 of
the Social Security Act) prohibits a physician from referring Medicare and
Medicaid beneficiaries to an entity for "designated health services"--including
prosthetics, orthotics and prosthetic devices and supplies--if the physician
has either an investment interest in the entity or a compensation arrangement
with the entity. An exception is recognized for referrals made to a publicly
traded entity in which the physician has an investment interest if the entity's
shares are traded on certain exchanges, including the New York Stock Exchange,
and had shareholders' equity exceeding $75.0 million for its most recent fiscal
year, or on average during the three previous fiscal years. We meet these
tests.
ANTITRUST
We are subject to federal and state antitrust laws which prohibit,
among other things, the establishment of ventures that result in certain
anticompetitive conduct. These laws have been applied to the establishment of
certain networks of otherwise competing health care provider. In September
1995, the Antitrust Division of the Department of Justice issued a business
review letter which concluded, in part, that the description of OPNET
voluntarily furnished to the Department of Justice by us "did not pose any
significant competitive issues" and, therefore, Department of Justice "has no
present intention of challenging {OPNET}" under federal antitrust law. Although
we are not able to assure that the continued operation of OPNET will comply in
all respects with the terms specified in the business review letter,
noncompliance with these terms does not mean that the antitrust authorities or
private parties would challenge the conduct, and we believe that the current
operation of OPNET is not anticompetitive and results in significant
efficiencies. However, the Department of Justice reserves the right to bring an
investigation or proceeding if it determines that OPNET is anticompetitive in
purpose or effect. There can be no assurance that the Department of Justice
will not bring an investigation or proceeding challenging OPNET (or other
aspects of our operations) under these laws, or that such an investigation or
proceeding would not result in a material adverse effect on our business and
results of operations.
PERSONNEL
None of our employees are subject to a collective-bargaining
agreement. We believe that we have satisfactory relationships with its
employees and strives to maintain these relationships by offering competitive
benefit packages, training programs and opportunities for advancement. The
following table summarizes our employees as of December 31, 1999:
<TABLE>
<S> <C>
Part-time...................................................... 229
Full-time...................................................... 3,302
-------
Total..................................................... 3,531
</TABLE>
15
<PAGE> 18
INSURANCE
We currently maintain insurance of the type and in the amount
customary in the orthopedic rehabilitation industry, including coverage for
malpractice liability, product liability, workers' compensation and property
damage. Our general liability insurance coverage is $500,000 per incident, with
a $50 million umbrella insurance policy. Based on our experience and prevailing
industry practices, we believe our coverage is adequate as to risks and amount.
ITEM 2. PROPERTIES.
As of December 31, 1999, Hanger operated 617 patient-care centers and
facilities in 41 states and the District of Columbia. Of these, 27 centers are
owned by Hanger. The remaining centers are occupied under leases expiring
between the years of 2000 and 2009. 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 H 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.
16
<PAGE> 19
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 55 Chairman of the Board, President, Chief Executive
Officer and Director of the Company
Richmond L. Taylor 51 Executive Vice President of the Company and Chief
Operating Officer of Hanger Prosthetics &
Orthotics, Inc. and NovaCare O&P, Inc. (Patient-
Care Services)
Richard A. Stein 40 Executive Vice President, Chief Financial Officer,
Secretary and Treasurer of the Company
James G. Cairns, Jr. 62 President and Chief Operating Officer of
Seattle Orthopedic Group, Inc. (Manufacturing)
Ron May 53 President and Chief Operating Officer of
Southern Prosthetic Supply, Inc. (Distribution)
</TABLE>
- ------------------------
Ivan R. Sabel has been Chairman of the Board and Chief Executive
Officer of Hanger since August 1995. He has been the President of Hanger since
October 14, 1999, and also served as President from November 1987 to July 1,
1999. Mr. Sabel also served as the Chief Operating Officer of Hanger from
November 1987 to August 1995. Prior to that time, Mr. Sabel had been Vice
President - Corporate Development from September 1986 to November 1987. From
1968 until joining Hanger in 1986, Mr. Sabel was the founder and President of
Capital Orthopedics, Inc. before that company was acquired by Hanger. Mr. Sabel
is a Certified Prosthetist and Orthotist ("CPO"), a member of the Board of
Directors of the American Orthotic and Prosthetic Association ("AOPA"), a
former Chairman of the National Commission for Health Certifying Agencies, a
former member of the Strategic Planning Committee and a current member of the
Veterans Administration Affairs Committee of AOPA and a former President of the
American Board for Certification in Orthotics and Prosthetics. Mr. Sabel also
serves on the Board of Directors of Mid-Atlantic Medical Services, Inc., a
company engaged in the health care management services business.
Richmond L. Taylor was the Executive Vice President and Chief
Operating Officer of NovaCare O&P until July 1, 1999, when he became an
Executive Vice President of the Company and Chief Operating Officer of each of
Hanger Prosthetics & Orthotics, Inc. and NovaCare O&P,
17
<PAGE> 20
the two wholly-owned subsidiaries of the Company which operate all of our
patient-care centers. Previously, Mr. Taylor served as the Regional Vice
President of NovaCare O&P for the West Region since 1989. Prior to joining
NovaCare, Mr. Taylor spent 20 years in the health care industry in a variety of
management positions including Regional Manager at American Hospital Supply
Corporation, Vice President of Operations at Medtech, Vice President of Sales
at Foster Medical Corporation and Vice President of Sales at Integrated Medical
Systems.
Richard A. Stein has been Executive Vice President, Chief Financial
Officer, 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 LLP (formerly Coopers &
Lybrand, LLP) from September 1982 until he joined Hanger in 1987.
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.
Ron May has been the President and Chief Operating Officer of Southern
Prosthetic Supply, Inc., a wholly-owned subsidiary of the Company that
distributes orthotic and prosthetic products, since December 1998. From January
1984 to December 1998, Mr. May was Executive Vice President of the distribution
division of J.E. Hanger, Inc. of Georgia until we acquired that company in
November 1996.
18
<PAGE> 21
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, 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
<CAPTION>
YEAR ENDED DECEMBER 31, 1999 HIGH LOW
---- ---
<S> <C> <C>
First Quarter $27.50 $12.00
Second Quarter 19.44 12.38
Third Quarter 15.00 10.50
Fourth Quarter 15.50 8.75
</TABLE>
At March 27, 2000, there were approximately 808 holders of record of
the Company's 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.
19
<PAGE> 22
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.
20
<PAGE> 23
<TABLE>
<CAPTION>
SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales $ 52,468 $ 66,806 $ 145,598 $ 187,870 $ 346,826
Gross profit 27,896 34,573 72,065 94,967 177,750
Selling, general & administrative 19,362 24,550 49,076 63,512 113,643
Depreciation and amortization 2,691 2,848 4,681 5,782 14,058
Integration costs (1) --- 2,480 --- --- 5,035
Restructuring costs (1) --- --- --- --- 1,305
Income from continuing operations 5,843 4,695 18,308 25,673 43,709
Interest expense, net (2,056) (2,547) (4,933) (1,902) (22,177)
Income (loss) before taxes,
extraordinary item 3,680 1,971 13,166 23,456 21,180
Provision for income taxes 1,544 890 5,526 9,616 10,194
Income (loss) before
extraordinary item 2,136 1,081 7,640 13,840 10,986
Extraordinary loss on early
extinguishment of debt --- (83) (2,694) --- ---
Net income (loss) $ 2,136 $ 998 $ 4,946 $ 13,840 $10,986
BASIC PER COMMON SHARE DATA:
Income (loss) before
extraordinary item $ 0.25 $ 0.12 $ 0.65 $ 0.82 $ 0.47
Extraordinary loss on early
extinguishment of debt --- (0.01) (0.23) --- ---
Net income (loss) per common share $ 0.25 $ 0.11 $ 0.42 $ 0.82 $ 0.47
========== ========= ========== ========== =========
Shares used to calculate basic per common
share amounts 8,291 8,470 11,793 16,813 18,555
========== ========= ========== ========== ========
DILUTED PER COMMON SHARE DATA:
Income (loss) before
extraordinary item $ 0.25 $ 0.12 $ 0.58 $ 0.75 $ 0.44
Extraordinary loss on early extinguishment
of debt --- (0.01) (0.21) --- ---
Net income (loss) per common share $ 0.25 $ 0.11 $ 0.37 $ 0.75 $ 0.44
========== ========= ========== ========== =========
Shares used to calculate diluted per common
share amounts 8,300 8,663 13,138 18,516 20,005
========== ========= ========== ========== =========
</TABLE>
21
<PAGE> 24
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------------------------
BALANCE SHEET DATA: 1995 1996 1997 1998 1999
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents $ 1,456 $ 6,572 $ 6,557 $ 9,683 $ 5,735
Working capital 20,622 25,499 39,031 49,678 118,428
Total assets 61,800 134,941 157,983 205,948 750,081
Long-term debt 22,925 64,298 23,237 11,154 426,211
Shareholders' equity 31,291 39,734 106,320 162,553 172,914
</TABLE>
(1) The 1996 results include acquisition and integration costs of $2.5
million incurred in connection with the purchase of JEH effective
November 1, 1996. The 1999 results include restructuring and
integration costs of $6.3 million incurred in connection with the
purchase of NovaCare O&P.
22
<PAGE> 25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
OVERVIEW
The significant growth in our net sales has resulted from an
aggressive program of acquiring and developing O&P patient-care centers.
Similarly, growth in our O&P distribution and manufacturing net sales is
attributable primarily to acquisitions. At December 31, 1999, the Company
operated 617 patient-care centers, six distribution facilities and two
manufacturing facilities.
EXPANSION
The following table sets forth the number of patient-care centers,
certified practitioners and states (including the District of Columbia) in
which we operated at the end of each of the past three years:
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Number of patient-care centers.......................... 213 256 617
Number of certified practitioners....................... 249 321 962
Number of states (including D.C.)....................... 30 31 42
</TABLE>
RECENT ACQUISITIONS
On July 1, 1999, we acquired NovaCare O&P for an aggregate
consideration of $445.0 million. NovaCare O&P, which operated 395 O&P patient
care centers at June 30, 1999, had net sales of approximately $278.8 million in
the twelve months ended June 30, 1999. Additionally, during 1999, we acquired
five O&P companies for an aggregate consideration, excluding potential earn-out
provisions, of approximately $11.9 million. These O&P companies, which operated
five patient-care centers at December 31, 1999, had combined net sales of
approximately $10.5 million in the year ended December 31, 1998.
SAME-CENTER NET SALES GROWTH
In addition to acquisitions of new patient-care centers, the growth in
our net sales from O&P patient-care services is attributable to a lesser degree
to increases in net sales from existing patient-care centers. The following
table sets forth, for the periods indicated, the percent increase (decrease) in
net sales contributed by those patient-care centers that were owned by us and
open during the entire period as well as the prior year's entire comparable
period:
23
<PAGE> 26
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------------------------
1997 1998 1999 (1)
---- ---- ----
<S> <C> <C> <C>
Percent increase (decrease) in
same-center net sales.............................. 11.7% 11.1% 4.1%
</TABLE>
- ---------------------------------
(1) Pro forma for the acquisition of NovaCare O&P as if the transaction
occurred on January 1, 1998. Adjusted 1998 base net sales for transaction
related issues in conjunction with the acquisition of NovaCare O&P.
SOURCES OF NET SALES
The majority of our net sales continue to be derived from operating
patient-care centers. The following table sets forth the percent contributed to
net sales in each of the periods indicated by the principal sources of our net
sales. Although manufacturing as a percent of net sales declined to 4.5% in
1998 versus 5.3% in 1997, there was an increase in the actual dollar amount of
net sales attributable to manufacturing in 1998. The decrease in the percentage
of net sales contributed by distribution activities and decrease in the
percentage of net sales attributable to manufacturing in 1999 is primarily a
result of the NovaCare O&P acquisition which was entirely patient care
services.
<TABLE>
<CAPTION>
For the Years Ended December 31,
-------------------------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Source of net sales:
Patient-care services............................. 77.1% 81.1% 88.6%
Manufacturing..................................... 5.3 4.5 3.0
Distribution...................................... 17.6 14.4 8.4
----------- ------------ -----------
100.0% 100.0% 100.0%
=========== ============ ===========
</TABLE>
PAYOR MIX
We receive payments for O&P services rendered to patients from private
insurers, HMOs, PPOs, the patients directly and governmental payors, including
Medicare, Medicaid and the VA. The sources and amounts of our net sales derived
from 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 our payor mix can affect our
profitability. The following table sets forth the percent contributed to net
sales in each of the following periods by the principal categories of payors:
24
<PAGE> 27
<TABLE>
<CAPTION>
For the Years Ended December 31,
-------------------------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Payor mix (1):
Private pay and other.................................... 38.0% 46.3% 59.0%
Medicare/Medicaid/VA/state
agencies.............................................. 62.0 53.7 41.0
---------- ---------- ----------
100.0% 100.0% 100.0%
========== ========== ==========
</TABLE>
- -----------------------------
(1) Payor mix data is based on a sampling of approximately 75% of the
patient care centers in 1997, approximately 41% of the patient-care
centers in 1998 and approximately 79% of the patient care centers in
1999.
EBITDA AND OPERATING MARGIN TRENDS
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%. In 1999, margins were higher than 1998, primarily
as a result of (i) the acquisition of NovaCare O&P which was entirely patient
care services; patient care services historically have experienced higher
margins than distribution and manufacturing operations and (ii) the elimination
of duplicative overhead and corporate field personnel. The following table sets
forth our EBITDA and operating margins during each of the past three years:
<TABLE>
<CAPTION>
For the Years Ended December 31,
----------------------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
EBITDA margin (1)............................... 15.8% 16.7% 18.5%
Operating margin (2)............................ 12.6 13.7 14.4
</TABLE>
- ----------------------
(1) "EBITDA" is defined as net income (loss) before interest expense
(net), taxes, depreciation and amortization, discontinued
operations, restructuring and integration costs, other expense
(net), extraordinary items and accounting change. EBITDA is not a
measure of performance under GAAP. While EBITDA should not be
considered in isolation or as a substitute for net income, cash
flows from operating activities and other income or cash flow
statement data prepared in accordance with GAAP, or as a measure of
profitability or liquidity, management understands that EBITDA is
customarily used as a criteria in evaluating health care companies
and is a common metric used by lenders in debt covenants.
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<PAGE> 28
(2) "Operating" is defined as net income (loss) before interest expense,
taxes, discontinued operations, restructuring and integration costs,
extraordinary items and accounting change.
SEASONALITY
Our results of operations are affected by seasonal considerations. The
adverse weather conditions often experienced in certain geographical areas of
the United States during the first quarter of each year, together with a
greater degree of patients' sole responsibility for their insurance deductible
payment obligations during the beginning of each calendar year, have
contributed to lower Hanger Orthopedic Group's net sales during that quarter.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain items
of our statements of operations as a percentage of our net sales:
<TABLE>
<CAPTION>
For the Years Ended December 31,
---------------------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Net sales................................................ 100.0% 100.0% 100.0%
Cost of products & services sold......................... 50.5 49.5 48.7
Gross profit............................................. 49.5 50.5 51.3
Selling, general and administrative...................... 33.7 33.8 32.8
Depreciation and amortization............................ 2.0 1.8 1.9
Amortization of excess cost over net
assets acquired..................................... 1.2 1.3 2.2
Integration and restructuring costs....................... -- -- 1.8
Income from operations................................... 12.6 13.7 12.6
Interest expense, net.................................... 3.4 1.0 6.4
Income before taxes and extraordinary
item................................................ 9.0 12.5 6.1
Income taxes............................................. 3.8 5.1 2.9
Net income............................................... 3.4 7.4 3.2
</TABLE>
YEAR ENDED DECEMBER 31, 1999 COMPARED TO THE YEAR ENDED DECEMBER 31, 1998
NET SALES. Net sales for the year ended December 31, 1999 were
approximately $346.8 million, an increase of approximately $159.0 million, or
84.6%, over net sales of approximately $187.9 million for the year ended
December 31, 1998. Contributing to the increase were (i) the acquisition of
NovaCare O&P on July 1, 1999 and (ii) a 4.1% increase in sales by patient care
centers operating during both periods ("same store sales").
GROSS PROFIT. Gross profit for the year ended December 31 1999 was
approximately $177.8 million, an increase of approximately $82.8 million, or
87.2%, over gross profit of approximately $95.0 million for the year ended
December 31, 1998. The increase was primarily
26
<PAGE> 29
attributable to the increase in net sales. Gross profit as a percentage of net
sales increased to 51.3% in 1999 from 50.5% in 1998. The increase in the gross
profit margin is primarily a result of the NovaCare O&P acquisition which was
entirely patient care services. Patient care services historically have
experienced higher gross profit margins than distribution and manufacturing
operations.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general
and administrative expenses in the year ended December 31, 1999 increased by
approximately $50.1 million, or 78.9%, compared to the year ended December 31,
1998. Selling, general and administrative expenses as a percentage of net sales
in 1999 decreased to 32.8% from 33.8% in 1998. The decrease in selling, general
and administrative expenses as a percent of net sales is primarily the result
of (i) the acquisition of NovaCare O&P, which has lower selling, general and
administrative margins than the Company on a consolidated basis and (ii) the
elimination of duplicative overhead and corporate field personnel.
INTEGRATION AND RESTRUCTURING COSTS. As stated above, the Company
recognized approximately $6.3 million of integration and restructuring costs
during 1999 in connection with the Company's acquisition on July 1, 1999 of
NovaCare O&P. Additional information relating to the integration and
restructuring costs is set forth below under "Integration and Restructuring
Costs."
INCOME FROM OPERATIONS. Principally as a result of the above,
income from operations in the year ended December 31, 1999 was approximately
$43.7 million, an increase of approximately $18.0 million, or 70.3%, over the
prior year's comparable period. Income from operations as a percentage of net
sales decreased to 12.6% in 1999 from 13.7% in 1998.
INTEREST EXPENSE, NET. Interest expense, net for the year ended
December 31, 1999 was approximately $22.2 million, an increase of approximately
$20.3 over approximately $1.9 million incurred in the year ended December 31,
1998. Interest expense as a percentage of net sales increased to 6.4% from 1.0%
for the prior year. The increase in interest expense was primarily attributable
to $255.0 million borrowed under a bank credit facility and $150.0 million in
senior subordinated notes issued to acquire NovaCare O&P.
INCOME TAXES. The Company's effective tax rate was 48% in 1999
versus 41% in 1998. The increase in 1999 is a result of the disproportionate
impact of the amortization of the excess costs over net assets acquired in
relation to taxable income, primarily attributable to the acquisition of
NovaCare O&P. The provision for income taxes for the year ended December 31,
1999 was approximately $10.2 million compared to approximately $9.6 million for
the year ended December 31, 1998.
NET INCOME. As a result of the above, the Company recorded net
income of approximately $11.0 million, or $.44 per dilutive common share, in
the year ended December 31, 1999, compared to net income of approximately $13.8
million, or $.75 per dilutive common share, in 1998. Net income for 1999,
excluding the integration and restructuring costs, would have been $14.8
million, or $.63 per dilutive common share.
YEARS ENDED DECEMBER 31, 1998 AND 1997
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<PAGE> 30
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, which was approximately $22.9 million, or 31.8%, 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 from patient-care services was 53.5% and 53.3% in the
years ended December 31, 1998 and 1997, respectively. Gross profit as a
percentage of net sales from 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
percentage of net sales increased to 13.7% in 1998 from 12.6% in 1997.
INTEREST EXPENSE, NET. Interest expense, net 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 approximately
$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.
28
<PAGE> 31
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 approximately $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.
LIQUIDITY AND CAPITAL RESOURCES
The Company's consolidated working capital at December 31, 1999 was
approximately $118.4 million and cash and cash equivalents available were
approximately $5.7 million. The Company's cash resources were satisfactory to
meet its obligations for the year ended December 31, 1999.
On July 1, 1999, the Company entered into a new credit agreement (the
"Credit Agreement") with The Chase Manhattan Bank, Bankers Trust Company,
Paribas and certain other banks (the "Banks"), which consists of a $100.0
million Revolving Credit Facility, a $100.0 million Tranche A Term Facility and
$100.0 million Tranche B Term Facility. The Tranche A Term Facility and the
Revolving Credit Facility mature in six years on July 1, 2005 and the Tranche B
Term Facility matures in seven years and six months on January 1, 2007. The
Credit Agreement, as originally entered into, provided that the Tranche A Term
Facility and the Revolving Credit Facility would carry an annual interest rate
of adjusted LIBOR plus 2.50% or ABR plus 1.50%, and that the Tranche B Term
Facility would carry an annual interest rate of adjusted LIBOR plus 3.50% or
ABR plus 2.50%. In consideration for the Banks' waiver of the Company's
non-compliance with certain of the covenants under the Credit Agreement in the
fourth quarter of 1999, and a relaxation of certain of the financial covenants
relating to 2000 and 2001, an amendment to the Credit Agreement was entered
into and provides for an increase in the Tranche A Term Facility and the
Revolving Credit Facility annual interest note to adjusted LIBOR plus 3.00% or
ABR plus 2.00%, and an increase in the Tranche B Term Facility annual interest
rate to adjusted LIBOR plus 4.00% or ABR plus 3.00%. The Company expects to be
in compliance with the amended covenants. The Revolving Credit Facility is
available to Hanger for use in connection with future acquisitions and for
working capital and general corporate purposes.
The Company's total long term debt at December 31, 1999, including a
current portion of approximately $25.4 million, was approximately $451.6
million. Such indebtedness included: (i) $150.0 of 11.25% million Senior
Subordinated Notes due 2009 (ii) $55.0 million for the Revolving Credit
Facility; (iii) $100.0 million for Tranche A Term Facility; (iv) $100.0 million
for Tranche B Term Facility; and (v) a total of $46.6 million of other
indebtedness.
The Credit Facility with the Banks is collateralized by substantially
all the assets of the Company, restricts the payment of dividends, and contains
certain affirmative and negative covenants customary in an agreement of this
nature.
29
<PAGE> 32
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.
On July 1, 1999, the Company acquired all of the outstanding capital
stock of NovaCare O&P from NovaCare, Inc. pursuant to the terms of a Stock
Purchase Agreement (the "Agreement"). Under the terms of the Agreement, the
aggregate consideration totaled $445.0 million, which consisted of the
assumption of liabilities and other obligations of $38.4 million and the
balance in cash. Of the cash portion, $15.0 million was placed in escrow
pending the determination of any potential post closing adjustments relating to
working capital. If, as of July 1, 1999, the adjusted working capital of
NovaCare O&P is less than approximately $94.0 million, the cash portion of the
purchase price will be reduced by the amount of such deficiency. If, however,
the adjusted working capital exceeds approximately $94.0 million, the cash
portion will be increased by the amount of the excess. For purposes of this
calculation, adjusted working capital will be comprised of cash in an amount of
at least $2.0 million, accounts receivable, inventory, other current assets,
accounts payable, and accrued expenses to third-parties (excluding all
inter-company obligations, accrued but unpaid taxes and the current portion of
the promissory notes owed to sellers of businesses acquired by NovaCare O&P).
The Company and NovaCare, Inc. have disagreed on the amount by which the cash
portion of the purchase price will be required to be decreased based on the
need for a post-closing working capital adjustment. It is expected that the
final amount of the required working capital adjustment will be determined by
an independent certified public accounting firm during the second quarter of
2000 in accordance with the dispute resolution arbitration mechanism provided
for under the Agreement.
Hanger required approximately $430.2 million in cash to close the
acquisition of NovaCare O&P, to pay approximately $20.0 million of related fees
and expenses, including debt issue costs of approximately $16.0 million, and to
refinance existing debt of approximately $2.5 million. The funds were raised by
Hanger through (i) borrowing approximately $230.0 million of revolving credit
and term loans under the Credit Agreement; (ii) selling $150.0 million
principal amount of 11.25% Senior Subordinated Notes due 2009; and (iii)
selling $60.0 million of 7% Redeemable Preferred Stock. The new bank credit
facility consists of a $100.0 million revolving credit facility, of which $30.0
million was drawn on in connection with the acquisition of NovaCare O&P, a
Tranche A Term Facility and a Tranche B Term Facility. The 7% Redeemable
Preferred Stock accrues annual dividends, compounded quarterly, equal to 7%, is
subject to put rights and will not require principal payments prior to
maturity. Such Preferred Stock is convertible into shares of the Company's
non-voting common stock at a price of $16.50 per share. During the quarter
ended September 30, 1999, the Mandatorily Redeemable Preferred Stock Class F,
of which no shares had been issued, was retired.
As stated above, the Company sold $60.0 million of 7% Redeemable Preferred
Stock on July 1, 1999 in connection with its acquisition of NovaCare O&P. The
60,000 outstanding shares of 7% Redeemable Preferred Stock are convertible into
shares of the Company's non-voting common stock at a price of $16.50 per share,
subject to adjustment. The Company is entitled to require that
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<PAGE> 33
the 7% Redeemable Preferred Stock be converted into non-voting common stock on
and after July 2, 2002, if the average closing price of the common stock for 20
consecutive trading days is equal to or greater than 175% of the conversion
price. The 7% Redeemable Preferred Stock will be mandatorily redeemable on July
1, 2010 at a redemption price equal to the liquidation preference plus all
accrued and unpaid dividends. In the event of a change in control of the
Company, it must offer to redeem all of the outstanding 7% Redeemable Preferred
Stock at a redemption price equal to 101% of the sum of the per share
liquidation preference thereof plus all accrued and unpaid dividends through
the date of payment.
The Company plans to finance future acquisitions through internally
generated funds or borrowings under the Revolving Credit Facility, the issuance
of notes or shares of Common Stock of the Company, or through a combination
thereof.
The Company is actively engaged in ongoing discussions with
prospective acquisition candidates. The Company plans to continue to expand its
operations aggressively through acquisitions.
INTEGRATION AND RESTRUCTURING COSTS
The Company has made an assessment of the restructuring costs to be
incurred relative to the acquisition of NovaCare O&P. Affected by the plan of
restructuring are approximately 54 patient care centers to be closed, including
approximately 29 Hanger and 25 NovaCare O&P locations. The Company began
formulating, and commenced, a plan of restructuring on July 1, 1999, which is
substantially complete. Since commencement of the plan of restructuring, the
Company has transitioned patients being cared for at closed patient care
centers to other patient care centers generally within proximity to a closed
branch. During 1999, the Company recorded approximately $5.6 million in
restructuring liabilities for the costs associated with the restructuring of
the NovaCare O&P operations and allocated such costs to the purchase price of
NovaCare O&P in accordance with purchase accounting requirements. The Company
also accrued approximately $1.3 million ($.8 million after tax) for the costs
associated with the restructuring of the existing Hanger operations in
conjunction with the NovaCare O&P acquisition and the Company has recorded such
charges in the statement of income.
The above-referenced restructuring costs primarily include severance
pay benefits and lease termination costs. The cost of providing severance pay
and benefits for the reduction of approximately 225 employees is estimated at
approximately $3.4 million and is primarily a cash expense. Total expected
employee terminations include approximately 70 acquired corporate and 155
patient-care center employees. Employees terminated at patient-care centers
include most, if not all, employees at each patient care center to be closed.
During 1999, approximately 195 employees were terminated including
approximately 53 acquired corporate employees and 142 patient care center
employees. Lease termination costs for patient care centers to be closed, are
estimated at $3.5 million, are cash expenses and are expected to be paid
through 2003. During 1999, 43 patient care centers were closed.
The Company estimates that the plan of restructuring Hanger and
NovaCare O&P operations, when complete, will generate annual cost savings of
approximately $13.0 million ($8.0
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<PAGE> 34
million after-tax) on a full year basis, excluding anticipated reductions in
material purchase costs. The foregoing restructuring charges and related cost
savings represent the Company's best estimates, but necessarily make numerous
assumptions with respect to industry performance, general business and economic
conditions, raw materials and product pricing levels, government legislation,
the timing of implementation of the restructuring and related employee
reductions and patient care center closings and other matters, many of which
are outside of the Company's control. The Company's estimate of cost savings is
not necessarily indicative of future performance, which may be significantly
more or less favorable than as set forth and is subject to the considerations
described below under "Forward Looking Statements".
Additionally, in relation to the acquisition of NovaCare O&P, during
the last half of 1999 the Company recorded integration costs of approximately
$5.0 million including costs of changing patient care center names, payroll and
related benefits conversion, stay-bonuses and related benefits for transitional
employees and certain other costs related to the acquisition.
NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standard Board issued SFAS
133, "Accounting for Derivative Instruments and Hedging Activities," which is
effective for fiscal years beginning after June 15, 2000. SFAS 133 requires
that an entity recognize all derivative instruments as either assets or
liabilities on its balance sheet at their fair value. Changes in the fair value
of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part
of a hedge transaction, and, if it is, the type of hedge transaction. The
Company will adopt SFAS 133 by the first quarter of 2001. 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.
The Company is currently upgrading its patient-care, manufacturing and
headquarters information systems. Included in the upgrading was a program to
ensure that all significant computer systems are substantially Year 2000
compliant. The Year 2000 compliance program, which was complete by the end of
1999, included the (1) identification of all information technology systems and
non-information technology systems that were 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. It
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<PAGE> 35
uses commercially developed software, the majority of which is constantly
upgraded through existing maintenance contracts.
Based on the Company's experience to date in 2000, its operations have
not been adversely affected to date by Year 2000 or leap year problems. The
total costs for the Company's Year 2000 program were approximately $1.3
million, which was expended during 1999.
FORWARD LOOKING STATEMENTS
This report contains forward-looking statements setting forth the
Company's beliefs or expectations relating to future revenues. Actual results
may differ materially from projected or expected results due to changes in the
demand for the Company's O&P services and products, uncertainties relating to
the results of operations or recently acquired and newly acquired O&P patient
care practices, the Company's ability to successfully integrate the operations
of NovaCare O&P and to attract and retain qualified O&P practitioners,
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.
33
<PAGE> 36
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
In the normal course of business, the Company is exposed to
fluctuations in interest rates. The Company addresses this risk by using
interest rate swaps from time to time. At December 31, 1999 there were no
interest rate swaps outstanding.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements and schedules required hereunder
and contained herein are listed under Item 14(a) below. 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.
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<PAGE> 37
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, 1998
and 1999
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<PAGE> 38
Consolidated Statements of Income for the years
ended December 31, 1997, 1998 and 1999
Consolidated Statements of Changes in Shareholders'
Equity for the years ended December 31,
1997, 1998 and 1999
Consolidated Statements of Cash Flows for the years
ended December 31, 1997, 1998 and 1999
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, 1999.
(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.)
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<PAGE> 39
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) Certificate of Amendment to Certificate of Incorporation
of the Registrant, as filed with the Secretary of
State of Delaware on September 16, 1999.
(Incorporated herein by reference to Exhibit 3 to
the Registrant's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1999.)
3(g) Certificate of Designation, Rights and Preferences of 7%
Redeemable Preferred Stock as filed with the Office
of the Secretary of State of Delaware on June 28,
1999. (Incorporated herein by reference to Exhibit
2(b) to the Registrant's Current Report of Form 8-K
dated July 1, 1999.)
3(h) Certificate of Elimination of Class A, B, C, D, E and F
Preferred Stock of the Registrant as filed with the
Office of the Secretary of State of Delaware on June
18, 1999. (Incorporated herein by reference to
Exhibit 2(c) to the Registrant's Current Report on
Form 8-K dated July 1, 1999.)
3(i) By-Laws of the Registrant, as amended. (Incorporated
herein by reference to Exhibit 3 to the Registrant's
Current Report on Form 8-K dated May 15, 1989.)
10(a) Registration Agreement, dated May 15, 1989, between
Sequel Corporation, First Pennsylvania Bank, N.A.,
Gerald E. Bisbee, Jr., Ivan R. Sabel, Richard A.
Stein, Ronald J. Manganiello, Joseph M. Cestaro and
Chemical Venture Capital Associates. (Incorporated
herein by reference to Exhibit 10(l) to the
Registrant's Current Report on Form 8-K dated May
15, 1989.)
10(b) First Amendment dated as of February 12, 1990, to the
Registration Agreement, dated as of May 15, 1989, by
and among Hanger Orthopedic Group, Inc., First
Pennsylvania Bank, N.A., Ivan R. Sabel, Richard A.
Stein, Ronald J. Manganiello, Joseph M. Cestaro and
Chemical Venture Capital Associates. (Incorporated
herein by reference to Exhibit 10(m) to the
Registrant's Current Report on Form 8-K dated
February 13, 1990.)
10(c) Fifth Amendment, dated as of November 8, 1990, to the
Stock and Note Purchase Agreement, dated as of
February 28, 1989 and as amended on May 9, 1989, May
15, 1989, February 12, 1990, and June 19, 1990 by
and among
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<PAGE> 40
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.) *
10(e) Warrants to purchase Common Stock of Hanger Orthopedic
Group, Inc. issued November 1, 1996. (Incorporated
herein by reference to Exhibit 10(c) to the
Registrant's Current Report on Form 8-K filed on
November 12, 1996.)
10(f) 1991 Stock Option Plan of the Registrant, as amended
through September 16, 1999. (Incorporated herein by
reference to Exhibit 4(a) to the Registrant's Proxy
Statement, dated July 28, 1999, relating to the
Registrant's Annual Meeting of Stockholders held on
September 8, 1999.)*
10(g) 1993 Non-Employee Directors Stock Option Plan of the
Registrant. (Incorporated herein by reference to
Exhibit 4(b) to the Registrant's Registration
Statement on Form S-8 (File No. 33-63191).)*
10(h) Employment and Non-Compete Agreement, dated as of
November 1, 1996, and Amendment No. 1 thereto, dated
January 1, 1997, between the Registrant and H.E.
Thranhardt. (Incorporated herein by reference to
Exhibit 10(p) to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1997.)
10(i) Employment and Non-Compete Agreement, dated as of
November 1, 1996, between the Registrant and John
McNeill. (Incorporated herein by reference to
Exhibit 10(q) to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1997.)
10(j) Asset Purchase Agreement, dated as of March 26, 1997, by
and between Hanger Prosthetics & Orthotics, Inc.,
Acor Orthopaedic, Inc., and Jeff Alaimo, Greg Alaimo
and Mead Alaimo. (Incorporated by reference to
Exhibit 2 to the Current Report on Form 8-K filed by
the Registrant on April 15, 1997.)
* Management contract or compensatory plan
38
<PAGE> 41
10(k) Asset purchase Agreement, dated as of May 8, 1997, by
and between Hanger Prosthetics & Orthotics, Inc.,
Fort Walton Orthopedic, Inc., Mobile Limb and Brace,
Inc. and Frank Deckert, Ronald Deckert, Thomas
Deckert, Robert Deckert and Charles Lee.
(Incorporated by reference to Exhibit 2 to the
Current Report on Form 8-K filed by the Registrant
on June 5, 1997.)
10(l) Asset Purchase Agreement, dated as of November 3, 1997,
by and between Hanger Prosthetics & Orthotics, Inc.,
Morgan Prosthetic-Orthotics, Inc. and Dan Morgan.
(Incorporated herein by reference to Exhibit 10(v)
to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1997.)
10(m) Asset Purchase Agreement, dated as of December 23, 1997,
by and between Hanger Prosthetics & Orthotics, Inc.,
Harshberger Prosthetic & Orthotic Center, Inc.,
Harshberger Prosthetic & Orthotic Center of Mobile,
Inc., Harshberger Prosthetic & Orthotic Center of
Florence, Inc., FAB-CAM, Inc. and Jerald J.
Harshberger. (Incorporated herein by reference to
Exhibit 10(w) to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1997.)
10(n) Stock Purchase Agreement, dated as of April 2, 1999, by
and among NovaCare, Inc., NC Resources, Inc., the
Registrant and HPO Acquisition Corporation,
Amendment No. 1 thereto, dated as of May 19, 1999,
and Amendment No. 2 thereto, dated as of June 30,
1999. (Incorporated herein by reference to Exhibit
2(a) to the Registrant's Current Report on Form 8-K
dated July 15, 1999.)
10(o) Indenture, dated as of June 16, 1999, among the
Registrant, its subsidiaries and U.S. Bank Trust
National Association, as Trustee. (Incorporated
herein by reference to Exhibit 10(a) to the
Registrant's Current Report on Form 8-K dated July
1, 1999.)
10(p) Form of First Supplemental Indenture, dated as of August
12, 1999, to Indenture, dated as of June 16, 1999,
among the Registrant, its subsidiaries and U.S. Bank
Trust National Association, as Trustee. (Filed with
original Registration Statement on Form S-4 on
August 12, 1999.)
10(q) Credit Agreement, dated as of June 16, 1999, among the
Registrant, various bank lenders, and The Chase
Manhattan Bank, as administrative agent, collateral
agent and issuing bank, Chase Securities Inc., as
lead arranger and book manager, Bankers Trust
Company, as syndication agent, and Paribas, as
documentation agent. (Incorporated herein by
reference to Exhibit 10(a) to the Registrant's
Current Report on Form 8-K dated July 1, 1999.)
39
<PAGE> 42
10(r) Senior Subordinated Note Purchase Agreement, dated as of
June 9, 1999, relating to 11.25% Senior Subordinated
Notes due 2009, among the Registrant, Deutsche Banc
Securities Inc., Chase Securities Inc. and Paribas
Corporation. (Incorporated herein by reference to
Exhibit 10(b) to the Registrant's Current Report on
Form 8-K dated July 1, 1999.)
10(s) Registration Rights Agreement, dated as of June 16,
1999, by and among the Registrant, Deutsche Banc
Securities, Inc., Chase Securities Inc. and Paribas
Corporation, relating to the 11.25% Senior
Subordinated Notes due 2009. (Incorporated herein by
reference to Exhibit 10(d) to the Registrant's
Current Report on Form 8-K dated July 1, 1999.)
10(t) Securities Purchase Agreement, dated as of June 16, 1999,
Relating to 7% Redeemable Preferred Stock, among the
Registrant, Chase Equity Associates, L.P. and
Paribas North America, Inc. (Incorporated herein by
reference to Exhibit 10(e) to the Registrant's
Current Report on Form 8-K dated July 1, 1999.)
10(u) Investor Rights Agreement, dated July 1, 1999, among the
Registrant, Chase Equity Associates, L.P. and
Paribas North America, Inc. (Incorporated herein by
reference to Exhibit 10(f) to the Registrant's
Current Report on Form 8-K dated July 1, 1999.)
10(v) Employment Agreement, dated as of April 29, 1999,
between the Registrant and Ivan R. Sabel.
(Incorporated herein by reference to Exhibit 10(r)
to the Registrant's Registration Statement on Form
S-4 (File No. 333-85045).)*
10(w) Employment Agreement, dated as of April 29, 1999,
between the Registrant and Richard A. Stein.
(Incorporated herein by reference to Exhibit 10(s)
to the Registrant's Registration Statement on Form
S-4 (File No. 333-85045).)*
10(x) Employment Agreement, dated as of July 1, 1999, between
the Registrant and Rick Taylor. (Incorporated herein
by reference to Exhibit 10(u) to the Registrant's
Registration Statement on Form S-4 (File No.
333-85045).)*
10(y) Employment Agreement, dated as of August 1, 1998,
between DOBI-Symplex, Inc., a subsidiary of the
Registrant, and James G. Cairns, Jr. (Incorporated
herein by reference to Exhibit 10(v) to the
Registrant's Registration Statement on Form S-4
(File No. 333-85045).)*
* Management contract or compensatory plan
40
<PAGE> 43
10(z) Employment Agreement, dated as of November 1, 1996,
between the Registrant and Ron May. (Incorporated
herein by reference to Exhibit 10(w) to the
Registrant's Registration Statement on Form S-4
(File No. 333-85045).)*
21 List of Subsidiaries of the Registrant. (Incorporated
herien by reference to Exhibit 21 to the Registrant's
Registration Statement on Form s-4 (File No.
333-85045).)
23 Consent of PricewaterhouseCoopers LLP
27 Financial Data Schedule for the year ended December 31,
1999
* Management contract or compensatory plan
<PAGE> 44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
HANGER ORTHOPEDIC GROUP, INC.
Dated: March 30, 2000 By: IVAN R. SABEL
----------------------------
Ivan R. Sabel, CPO
Chief Executive Officer
(Principal Executive Officer)
Dated: March 30, 2000 By: RICHARD A. STEIN
----------------------------
Richard A. Stein
Executive Vice President and
Chief Financial Officer
(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 30, 2000 IVAN R. SABEL
----------------------------
Ivan R. Sabel, CPO
Chief Executive Officer
and Director (Principal
Executive Officer)
Dated: March 30, 2000 RICHARD A. STEIN
----------------------------
Richard A. Stein
Executive Vice President and
Chief Financial Officer
Treasurer and Secretary
(Principal Financial and
Accounting Officer)
42
<PAGE> 45
Dated: March 30, 2000 MITCHELL J. BLUTT, M.D.
----------------------------
Mitchell J. Blutt, M.D.
Director
----------------------------
Edmond E. Charrette, M.D.
Director
Dated: March 30, 2000 THOMAS P. COOPER, M.D.
----------------------------
Thomas P. Cooper, M.D.
Director
Dated: March 30, 2000 ROBERT J. GLASER, M.D.
----------------------------
Robert J. Glaser, M.D.
Director
----------------------------
C. Raymond Larkin, Jr.
Director
Dated: March 30, 2000 RISA J. LAVIZZO-MOUREY, M.D.
----------------------------
Risa J. Lavizzo-Mourey, M.D.
Dated: March 30, 2000 WILLIAM L. MCCULLOCH
----------------------------
William L. McCulloch
Director
----------------------------
H.E. Thranhardt, CPO
Director
43
<PAGE> 46
INDEX TO FINANCIAL STATEMENTS
HANGER ORTHOPEDIC GROUP, INC.
Report of Independent Accountants F-1
Consolidated balance sheets as of December 31, 1998
and 1999 F-2
Consolidated statements of income for the years
ended December 31, 1997, 1998 and 1999 F-4
Consolidated statements of changes in shareholders'
equity for the years ended December 31, 1997,
1998 and 1999 F-5
Consolidated statements of cash flows for the years
ended December 31, 1997, 1998 and 1999 F-6
Notes to Consolidated Financial Statements F-7
FINANCIAL STATEMENT SCHEDULE
Schedule II - Valuation and Qualifying Accounts S-1
44
<PAGE> 47
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Hanger Orthopedic Group, Inc.
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) present fairly, in all material respects, the
financial position of Hanger Orthopedic Group, Inc. and Subsidiaries at
December 31, 1998 and 1999, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
In addition, in our opinion, the financial statement schedule listed in the
index appearing under Item 14(a)(2) presents fairly, in all material respects,
the information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in
the United States, 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 the opinion expressed above.
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
March 29, 2000
F-1
<PAGE> 48
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------
1998 1999
---------------------- ---------------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $9,683 $5,735
Accounts receivable, less allowances for doubtful accounts
of $8,022 and $17,866 in 1998 and
1999, respectively 39,157 103,125
Inventories 16,935 59,915
Prepaid expenses and other assets 3,539 5,222
Income taxes receivable 525 3,644
Deferred income taxes 4,497 11,778
---------------------- ---------------------
Total current assets 74,336 189,419
---------------------- ---------------------
PROPERTY, PLANT AND EQUIPMENT
Land 4,267 4,177
Buildings 8,523 8,886
Machinery and equipment 13,009 26,677
Furniture and fixtures 2,981 8,629
Leasehold improvements 4,263 13,004
---------------------- ---------------------
33,043 61,373
Less accumulated depreciation and amortization 10,334 15,269
---------------------- ---------------------
22,709 46,104
---------------------- ---------------------
INTANGIBLE ASSETS
Excess cost over net assets acquired 114,075 498,612
Non-compete agreements 1,724 2,019
Patents --- 9,768
Assembled work force --- 7,000
Other intangible assets 2,702 15,833
---------------------- ---------------------
118,501 533,232
Less accumulated amortization 10,545 20,412
---------------------- ---------------------
107,956 512,820
---------------------- ---------------------
OTHER ASSETS
Other 947 1,738
---------------------- ---------------------
TOTAL ASSETS $205,948 $750,081
====================== =====================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
F-2
<PAGE> 49
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------
1998 1999
------------------- ------------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt $4,407 $25,406
Accounts payable 4,976 16,714
Accrued expenses 6,156 5,445
Accrued interest payable 118 4,768
Accrued compensation related cost 9,001 18,658
------------------- ------------------
Total current liabilities 24,658 70,991
------------------- ------------------
Long-term debt 11,154 426,211
Deferred income taxes 5,223 13,481
Other liabilities 2,360 7,259
7% Redeemable Convertible Preferred stock, liquidation preference $1,000 per share --- 59,225
Commitments and contingent liabilities (See Note K)
SHAREHOLDERS' EQUITY
Common stock, $.01 par value; 60,000,000 shares authorized, 18,825,372 and
19,043,497 shares issued and 18,691,877 and
18,910,002 shares outstanding in 1998 and 1999, respectively 188 190
Additional paid-in capital 144,970 146,498
Retained earnings 18,051 26,882
------------------- ------------------
163,209 173,570
Treasury stock, cost -- (133,495 shares) (656) (656)
------------------- ------------------
162,553 172,914
------------------- ------------------
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY $205,948 $750,081
=================== ==================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
F-3
<PAGE> 50
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1997 1998 1999
---------- ---------- ---------
<S> <C> <C> <C>
Net sales $ 145,598 $ 187,870 $ 346,826
Cost of products and services sold 73,533 92,903 169,076
----------- ----------- -----------
Gross profit 72,065 94,967 177,750
Selling, general and administrative 49,076 63,512 113,643
Depreciation and amortization 2,871 3,294 6,538
Amortization of excess cost over net assets acquired 1,810 2,488 7,520
Restructuring costs --- --- 1,305
Integration costs --- --- 5,035
----------- ----------- -----------
Income from operations 18,308 25,673 43,709
Interest expense, net (4,933) (1,902) (22,177)
Other expense, net (209) (315) (352)
----------- ----------- -----------
Income before taxes and extraordinary item 13,166 23,456 21,180
Provision for income taxes 5,526 9,616 10,194
----------- ----------- -----------
Income before extraordinary item 7,640 13,840 10,986
Extraordinary loss on early extinguishment of debt, net of tax benefit (2,694) --- ---
----------- ----------- -----------
Net income $ 4,946 $ 13,840 $ 10,986
=========== =========== ===========
Income before extraordinary item applicable to common stock $ 7,614 $ 13,817 $ 8,831
=========== =========== ===========
Basic Per Common Share Data
- ---------------------------
Income before extraordinary item $ 0.65 $ 0.82 $ 0.47
Extraordinary item, net of tax benefit (0.23) --- ---
----------- ----------- -----------
Net income $ 0.42 $ 0.82 $ 0.47
=========== =========== ===========
Shares used to compute basic per common share amounts 11,792,892 16,812,717 18,854,751
Diluted Per Common Share Data
- ---------------------------
Income before extraordinary item $ 0.58 $ 0.75 $ 0.44
Extraordinary item, net of tax benefit (0.21) ---- ---
----------- ----------- -----------
Net income * $ 0.37 $ 0.75 $ 0.44
=========== =========== ===========
Shares used to compute diluted per common share amounts * 13,138,377 18,515,567 20,005,282
</TABLE>
* For 1999, excludes the effect of the conversion of common stock into which
7% Redeemable Convertible Preferred Stock into Common Stock as it is
considered anti-dilutive.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
F-4
<PAGE> 51
HANGER ORTHOPEDIC GROUP, INC
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
(IN THOUSANDS)
<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, 1996 9,316 $ 94 $ 41,009 $ (713) $ (656) $ 39,734
Preferred dividends declared (26) (26)
Net Income 4,946 4,946
Issuance of Common Stock in
connection with the exercise
of stock options 395 4 2,823 2,827
Issuance of Common Stock in
connection with the exercise
of stock warrants 12 0
Issuance of Common Stock in
connection with the purchase
of Fort Walton Mobile 64 1 499 500
Issuance of Common Stock in
Public Offering 5,750 58 58,281 58,339
------ --- ------- ------ ---- -------
Balance, December 31, 1997 15,537 157 102,586 4,233 (656) 106,320
------ --- ------- ------ ---- -------
Preferred dividends declared (22) (22)
Net Income 13,840 13,840
Issuance of Common Stock in
connection with the exercise
of stock options 338 3 2,252 2,255
Issuance of Common Stock in
connection with the exercise
of stock warrants 276 3 (3) 0
Issuance of Common Stock in
connection with acquisitions 141 1 2,399 2,400
Issuance of Common Stock in
Public Offering 2,400 24 37,736 37,760
------ --- ------- ------ ---- -------
Balance, December 31, 1998 18,692 188 144,970 18,051 (656) 162,553
------ --- ------- ------ ---- -------
Preferred dividends declared (2,118) (2,118)
Accretion of Preferred Stock (37) (37)
Net Income 10,986 10,986
Issuance of Common Stock in
connection with the exercise
of stock options 184 2 861 863
Issuance of Common Stock in
connection with acquisitions 23 500 500
Issuance of Common Stock in
Public Offering
Conversion of Seller Notes
into Shares of Common Stock 11 167 167
------ --- ------- ------ ---- -------
Balance, December 31, 1999 18,910 $ 190 $146,498 $ 26,882 $ (656) $172,914
====== ===== ======== ======= ===== ========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
F-5
<PAGE> 52
HANGER ORTHOPEDIC GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1998 1999
----------- ------------- --------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $4,946 $13,840 $10,986
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Loss on disposal of assets --- --- 37
Provision for bad debt 5,613 7,510 15,046
Provision for inventory reserves 1,160 2,202 ---
Depreciation and amortization 2,871 3,294 6,538
Amortization of excess cost over net assets acquired 1,810 2,488 7,520
Amortization of debt discount and debt issue costs 152 --- 1,059
Deferred taxes 2,060 (554) 662
Restructuring costs --- --- 1,305
Extraordinary loss on early extinguishment of debt 4,644 --- ---
Changes in assets and liabilities, net of effects from acquired companies:
Accounts receivable (9,381) (10,773) (19,367)
Inventories (1,069) 256 (10,372)
Prepaid and other assets (2,587) 611 (2,493)
Other assets 176 (87) 1,156
Accounts payable (1,326) (586) 2,896
Accrued expenses (581) (67) (4,638)
Accrued wages & payroll taxes (401) 247 (6,127)
Other liabilities 25 150 (4,432)
----------- ------------- --------------
Net cash provided by operating activities 8,112 18,531 (224)
----------- ------------- --------------
Cash flow from investing activities:
Purchase of fixed assets (2,581) (2,859) (12,598)
Acquisitions, net of cash acquired (15,800) (30,333) (432,291)
Proceeds from sale of certain assets, net of cash --- --- 397
Purchase of patents (89) (60) (209)
Purchase of non-compete agreements (256) (398) (294)
----------- ------------- --------------
Net cash used in investing activities (18,726) (33,650) (444,995)
----------- ------------- --------------
Cash flow from financing activities:
Net borrowings under revolving credit agreement --- --- 55,000
Proceeds from issuance of preferred stock, net --- --- 59,188
Repayment of preferred stock --- (326) ---
Proceeds from issuance of Common Stock 61,166 40,016 863
Proceeds from long-term debt 8,256 6,000 350,000
Repayment of long-term debt (58,781) (27,445) (9,089)
Increase in financing costs (42) --- (14,691)
----------- ------------- --------------
Net cash provided by financing activities 10,599 18,245 441,271
----------- ------------- --------------
Increase (decrease) in cash and cash equivalents (15) 3,126 (3,948)
Cash and cash equivalents at beginning of year 6,572 6,557 9,683
----------- ------------- --------------
Cash and cash equivalents at end of year $6,557 $9,683 $5,735
=========== ============= ==============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED
FINANCIAL STATEMENTS.
F-6
<PAGE> 53
HANGER ORTHOPEDIC GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
NOTE A - THE COMPANY
Hanger Orthopedic Group, Inc. is the nation's largest professional
practice management 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
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.
Long-Lived Asset Impairment: The Company reviews its long-lived
assets for impairment whenever events or changes in circumstances indicate that
the carrying amount of the assets may not be recoverable through future cash
flows such as: a significant decrease in the market value of the
F-7
<PAGE> 54
Company's assets; or a significant adverse change in legal factors or in the
business climate that could affect the value of an asset or an adverse action
or assessment by a regulator; or a significant adverse change in third-party
reimbursement requirements. If it is determined that an impairment loss has
occurred based on expected cash flows undiscounted, before interest and taxes,
then the extent of the impairment is calculated, based on net cash flows and
the loss is recognized in the income statement. Management's review of future
cash flows associated with long-lived assets has not indicated an impairment of
those assets during the periods presented.
Property, Plant and Equipment: Property, plant and equipment are
recorded at cost. The cost and related accumulated depreciation of assets sold,
retired or otherwise disposed of are removed from the respective accounts, and
any resulting gains or losses are included in the statement of 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 - shorter of the asset life or term of lease; and
buildings - 10-20 years. Depreciation expense was approximately $2,173, $2,806
and $5,251 for the years ended December 31, 1997, 1998 and 1999, 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
F-8
<PAGE> 55
109 also provides for the recognition of deferred tax assets if it is more
likely than not that the assets will be realized in future years.
Stock-Based Compensation: Compensation costs attributable to stock
option and similar plans are recognized based on any difference between the
quoted market price of the stock on the date of the grant over the amount the
employee is required to pay to acquire the stock (the intrinsic value method
under Accounting Principles Board Opinion 25). SFAS 123, "Accounting for
Stock-Based Compensation," requires companies electing to continue to use the
intrinsic value method to make pro forma disclosures of net income and earnings
per share as if the fair value based method of accounting had been applied. The
Company has adopted the disclosure only provisions of SFAS 123.
Comprehensive Income: Effective January 1, 1998 the Company adopted
the provisions of SFAS 130, "Reporting Comprehensive Income." SFAS 130
establishes standards for reporting and display of comprehensive income and its
components in the financial statements. The adoption of SFAS 130 had no effect
on the Company's consolidated financial statements.
Segment Information: SFAS 131, "Disclosures about Segments of an
Enterprise and Related Information" applies a "management" approach to
disclosure of segment information. The management approach designates the
internal organization that is used by management for making operating decisions
and assessing performance as the source of the Company's reportable segments.
SFAS 131 also requires disclosure in 1998 about products and services,
geographic areas and major customers. The adoption of SFAS 131 in 1998 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, 2000. SFAS 133 requires that an entity recognize all derivative instruments
as either assets or liabilities on its balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designated as part of a hedge transaction, and, if it is, the type of hedge
transaction. The Company will adopt SFAS 133 by the first quarter of 2001. 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> 56
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,
--------------------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Cash paid during the period for:
Interest $ 5,361 $ 2,099 $ 18,261
Income taxes
2,469 8,307 12,400
Non-cash financing and investing activities:
Preferred stock dividends declared and accretion 26 22 2,155
Issuance of notes in connection with
acquisitions 8,314 7,934 3,006
Issuance of Common Stock in connection with
acquisitions 500 2,400 500
Conversion of seller notes into shares
of Common Stock --- --- 167
</TABLE>
NOTE D - ACQUISITIONS
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, comprised of $13,715 in cash, $8,314 in promissory
notes and 64,000 shares of Common Stock of the Company valued at $500. 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, comprised
of $28,791 in cash, $7,934 in promissory notes and 141,417 shares of common
stock of the Company valued at $2,400. The notes are payable over one to five
years with interest rates ranging from 6.0000% to 7.6875%. The cash portion of
the purchase price for these acquisitions was borrowed under the Company's
revolving and acquisition loan commitment.
During 1998, the Company paid approximately $591,000 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 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. Additional
amounts aggregating approximately $2,890 may be paid over the next five years
in connection with earnout provisions contained in the 1998 acquisition
agreements.
On July 1, 1999, the Company acquired all of the outstanding stock of
NovaCare Orthotics and Prosthetics, Inc. ("NovaCare O&P") from NovaCare, Inc.
pursuant to the terms of a Stock Purchase Agreement (the "Agreement"). Under
the terms of the Agreement, the aggregate consideration totaled $445,000, which
consisted of the assumption of liabilities and other
F-10
<PAGE> 57
obligations of $38,400 and the balance in cash. Of the cash portion, $15,000
was placed in escrow pending the determination of any potential post closing
adjustments relating to working capital. If, as of July 1, 1999, the adjusted
working capital of NovaCare O&P is less than approximately $94,000, the cash
portion of the purchase price will be reduced by the amount of such deficiency.
If, however, the adjusted working capital exceeds approximately $94,000, the
cash portion will be increased by the amount of the excess. For purposes of
this calculation, adjusted working capital will be comprised of cash in an
amount of at least $2,000, accounts receivable, inventory, other current
assets, accounts payable, and accrued expenses to third-parties (excluding all
inter-company obligations, accrued but unpaid taxes and the current portion of
the promissory notes owed to sellers of businesses acquired by NovaCare O&P).
Hanger required approximately $430,200 in cash to close the
acquisition, to pay approximately $20,000 of related fees and expenses,
including debt issue costs of approximately $16,000, and to refinance existing
debt of approximately $2,500. The funds were raised by Hanger through (i)
borrowing approximately $230,000 of revolving credit and term loans under a new
bank facility; (ii) selling $150,000 principal amount of 11.25% Senior
Subordinated Notes due 2009; and (iii) selling $60,000 of 7% Redeemable
Preferred Stock. The new bank credit facility consists of a $100,000 revolving
credit facility, of which $30,000 was drawn on in connection with the
acquisition of NovaCare O&P, an A term facility and a Tranche B term facility.
The acquisition of NovaCare O&P has been accounted for as a
business combination in accordance with the purchase method. The results of
operations for this acquisition have been included in the Company's results
since July 1, 1999. Excess cost over net assets acquired includes goodwill and
other intangible assets. Goodwill is amortized using the straight-line method
over 40 years. Other intangible assets of $15,000, primarily patents, are
amortized over periods of between 8 and 11 years.
The following represents the non-cash impact of the NovaCare O&P
acquisition:
Fair value of assets acquired, including goodwill $496,224
Liabilities assumed 82,358
--------
Cash paid $413,866
========
The ultimate purchase price for the NovaCare O&P acquisition is
subject to arbitration proceedings for which $15,000 has been maintained in an
escrow account pending those proceedings.
Included in liabilities assumed are restructure provisions which are
more fully described in Note E. Additionally, certain contingent liabilities,
more fully described in Note K, exist which, when resolved may result in
adjustment of the purchase price cost allocation.
Additionally, during 1999, the Company acquired five other orthotic
and prosthetic companies. The aggregate purchase price, excluding potential
earn-out provisions, was $12,070,
F-11
<PAGE> 58
comprised of $8,564, in cash, $2,880 in promissory notes and 23,002 shares of
Common Stock of the Company valued at $500.
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 $20,451, $32,925 and $374,550 in 1997,
1998 and 1999, 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>
1998 1999
---- ----
<S> <C> <C>
Net sales $492,417 $482,502
Net income (loss) 2,497 (1,609)
Diluted income (loss) per common share (1) ($.10) ($.31)
</TABLE>
(1) Excludes potentially dilutive Common Stock and includes an adjustment
to net income for Preferred Stock Dividends.
The unaudited consolidated pro forma results do not necessarily
represent results which would have occurred if the acquisitions had taken place
at the beginning of each period, nor are they indicative of the results of
future combined operations or trends.
Adjustments made in arriving at the unaudited consolidated pro forma
results include increased interest expense on acquisition debt, amortization of
goodwill, adjustments to the fair value of assets acquired and depreciable
lives, preferred stock dividends, restructure and integration costs and related
tax adjustments.
Additionally, the Company paid during 1999, approximately $9,861 and
issued $126 in notes related to seven orthotic and prosthetic companies
acquired in years prior to 1999. The payments were primarily made pursuant to
earnout and working capital provisions contained in the respective acquisition
agreements. The Company has accounted for these amounts as additional purchase
price resulting in an increase to excess of cost over net assets acquired in
the amount of $9,987. Additional amounts aggregating approximately $18,537 may
be paid in connection with earnout provisions contained in previous acquisition
agreements, primarily related to the NovaCare O&P business.
NOTE E -INTEGRATION & RESTRUCTURING COSTS
The Company has made an assessment of the restructuring costs to be
incurred relative to the acquisition of NovaCare O&P. Affected by the plan of
restructuring are approximately 54 patient care centers to be closed, including
approximately 29 Hanger and 25 NovaCare O&P locations. The Company began
formulating, and commenced, a plan of restructuring on July 1, 1999, which is
substantially complete. Since commencement of the plan of restructuring, the
Company had transitioned patients being cared for at closed patient care
centers to other patient care centers generally within proximity to a closed
branch. During 1999, the Company recorded approximately
F-12
<PAGE> 59
$5,615 in restructuring liabilities for the costs associated with the
restructuring of the NovaCare O&P operations and allocated such costs to the
purchase price of NovaCare O&P in accordance with purchase accounting
requirements. The Company also accrued approximately $1,305 ($796 after tax)
for the costs associated with the restructuring of the existing Hanger
operations in conjunction with the NovaCare O&P acquisition and the Company has
recorded such charges in the statement of income.
The above-referenced restructuring costs primarily include severance
pay benefits and lease termination costs. The cost of providing severance pay
and benefits for the reduction of approximately 225 employees is estimated at
approximately $3,368 and is primarily a cash expense. Total expected employee
terminations include approximately 70 acquired corporate and 155 patient-care
center employees. Employees terminated at patient-care centers include most, if
not all, employees at each patient care center to be closed. During 1999,
approximately 195 employees were terminated including approximately 53 acquired
corporate employees and 142 patient care center employees. Lease termination
costs, for patient care centers closed, are estimated at $3,510, are cash
expenses and are expected to be paid through 2003. During 1999, 43 patient care
centers were closed.
The components of the restructuring accrual are as follows:
<TABLE>
<CAPTION>
Transfer
Hanger NovaCare O&P against December 31,
business business Payments assets 1999
------------ ----------------- --------------- ------------- ----------------
<S> <C> <C> <C> <C> <C>
Employee severance costs $223 $3,145 $ (1,768) $1,600
Writedown of assets 42 100 $ (142) -
Lease termination and
other exit costs 1,040 2,470 (518) 2,992
------------ ----------------- --------------- ------------- ----------------
$1,305 $5,715 $ (2,286) $ (142) $ 4,592
============ ================= =============== ============= ================
</TABLE>
The restructuring accrual at December 31, 1999 consists of
approximately $1,592, $1,175 and $1,825 in accrued expenses, accrued
compensation related costs and other liabilities, respectively.
Additionally, in relation to the acquisition of NovaCare O&P, the
Company recorded integration costs of approximately $5,035 including costs of
changing patient care center names, payroll and related benefits conversion,
stay-bonuses and related benefits for transitional employees and certain other
costs related to the acquisition. These costs were expensed as incurred and
recorded against operations.
NOTE F - NET INCOME PER COMMON SHARE
Basic per common share amounts are computed using the weighted
average number of common shares outstanding during the year. Diluted per common
share amounts are computed using
F-13
<PAGE> 60
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,
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Income before extraordinary item $ 7,640 $ 13,840 $ 10,986
Less preferred stock dividends declared
and accretion (26) (22) (2,155)
----------- ----------- -----------
Income available to common
stockholders used to compute basic per
common share amounts $ 7,614 $ 13,817 $ 8,831
Add back interest expense on convertible
note payable, net of tax $ $ 44 $ 51
----------- ----------- -----------
Income available to common
stockholders plus assumed
conversions used to compute diluted $ 7,614 $ 13,862 $ 8,882
per common share amounts =========== =========== ===========
Shares of common stock outstanding used to
compute basic per common share amounts 11,792,892 16,812,717 18,854,751
Effect of convertible note payable -- 87,501 92,573
Effect of dilutive options 556,476 836,126 541,834
Effect of dilutive warrants 789,009 779,223 516,124
Shares used to compute dilutive per
----------- ----------- -----------
common share amounts (1) 13,138,377 18,515,567 20,005,282
=========== =========== ===========
Basic income per common share before
extraordinary item $ .65 $ .82 $ .47
Diluted income per common
share before extraordinary item $ .58 $ .75 $ .44
</TABLE>
(1) Common shares into which shares of 7% Redeemable Preferred Stock are
convertible were not included in the computation of diluted income
per common share for 1999 as the effect is considered anti-dilutive.
Options to purchase 234,250 and 665,333 shares of Common Stock were
outstanding at December 31 1998 and 1999, respectively, but were not included
in the computation of diluted income per share for 1998 and 1999 because the
options' prices were greater than the average market price of the common
shares.
NOTE G - INVENTORY
Inventories at December 31, 1998 and 1999 consist of the following:
<TABLE>
<CAPTION>
1998 1999
---- ----
<S> <C> <C>
Raw materials $ 7,196 $31,715
</TABLE>
F-14
<PAGE> 61
<TABLE>
<S> <C> <C>
Work in-process 2,094 17,172
Finished goods 7,645 11,028
------- -------
$16,935 $59,915
======= =======
</TABLE>
NOTE H - LONG-TERM DEBT
Long-term debt consists of the following at December 31, 1998 and
1999:
<TABLE>
<CAPTION>
1998 1999
---- ----
<S> <C> <C>
A-Term Loan Commitment --- $100,000
B Term Loan Commitment --- 100,000
Senior subordinated notes --- 150,000
Revolving credit facility --- 55,000
Subordinated seller notes, non-collateralized net
of unamortized discount of $294,438 and $195,529
at December 31, 1998 and 1999, 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. $15,561 46,617
------- ------
15,561 451,617
Less current portion 4,407 25,406
------- ------
$11,154 $426,211
======= =======
</TABLE>
During 1997, the Company sold 5,750,000 shares of Common Stock in a
underwritten public offering at $11.00 per share resulting in approximately
$58,300 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 a credit agreement being
substantially modified, the Company incurred an extraordinary loss of $4,600
($2,700 net of tax benefit).
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.
On June 16, 1999, the Company issued $150,000 of Senior Subordinated
Notes, bearing interest of 11.25%, and maturing on June 15, 2009. Interest is
payable on June 15 and December 15, commencing on December 15, 1999.
On July 1, 1999, the Company replaced its bank credit facility with a
new facility (the "Credit Agreement") which consists of a $100,000 Revolving
Credit Facility, a $100,000 Tranche A Term Facility and $100,000 Tranche B Term
Facility. The Tranche A Term Facility and the Revolving Credit Facility mature
on July 1, 2005 and the Tranche B Term Facility matures on January 1, 2007. The
Credit Agreement, as initially entered into, provided that the Tranche A Term
F-15
<PAGE> 62
Facility and the Revolving Credit Facility would carry an annual interest rate
of adjusted LIBOR plus 2.50% or ABR plus 1.50%, and that the Tranche B Term
Facility would carry an annual interest rate of adjusted LIBOR plus 3.50% or
ABR plus 2.50%. At December 31, 1999, the Company was not in compliance with
financial covenants under the Credit Agreement for capital expenditure and
adjusted interest coverage ratio. In consideration for the Banks' waiver of the
Company's non-compliance with these covenants, an amendment to the Credit
Agreement effective March 29, 2000 was entered into which provides for an
increase in the Tranche A Term Facility and the Revolving Credit Facility
annual interest rate to adjusted LIBOR plus 3.00% or ABR plus 2.00%, and an
increase in the Tranche B Term Facility annual interest rate to adjusted LIBOR
plus 4.00% or ABR plus 3.00%. Certain of the financial covenants were eased
with respect to 2000 and 2001 under the terms of the amendment to the Credit
Agreement. The Company expects to be in compliance with the amended covenants.
The Credit Facility with the Banks is collateralized by substantially
all the assets of the Company, restricts the payment of dividends, and contains
certain affirmative and negative covenants customary in an agreement of this
nature.
Maturities of long-term debt at December 31, 1999 are as follows:
<TABLE>
<S> <C>
2000 $25,406
2001 33,882
2002 31,801
2003 27,070
2004 77,018
Thereafter 256,440
---------
$451,617
=========
</TABLE>
NOTE I- INCOME TAXES
The provisions for income taxes for the years ended December 31,
1997, 1998 and 1999 consisted of the following:
F-16
<PAGE> 63
<TABLE>
<CAPTION>
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Current:
Federal $ 3,068 $ 8,683 $ 7,844
State 398 1,486 1,688
------- ------- -------
Total 3,466 10,169 9,532
Deferred:
Federal and State 2,060 (553) 662
------- ------- -------
Provision for income taxes on
income before extraordinary item 5,526 9,616 10,194
Tax benefit from extra-
ordinary item (1,951) --- ---
------- ------- -------
Provision for income taxes $ 3,575 $ 9,616 $10,194
======= ======= =======
</TABLE>
A reconciliation of the federal statutory tax rate to the effective
tax rate for the years ended December 31, 1997, 1998 and 1999 is as follows:
<TABLE>
<CAPTION>
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Federal statutory tax rate $ 4,608 $ 8,210 $ 7,413
Increase in taxes resulting from:
State income taxes (net of
federal effect) 606 985 1,196
Amortization of the excess cost
over net assets acquired 96 159 1,733
Other, net 216 262 (148)
-------- -------- -------
Provision for income taxes on
income before extraordinary item 5,526 9,616 10,194
Tax benefit from extraordinary
item (1,951) --- ---
------ -------- -------
Provision for income taxes $3,575 $ 9,616 $10,194
====== ======= =======
</TABLE>
Temporary differences and carryforwards which give rise to deferred
tax assets and liabilities as of December 31, 1998 and 1999 are as follows:
<TABLE>
<CAPTION>
1998 1999
---- ----
<S> <C> <C>
Deferred Tax Liabilities:
Book basis in excess of tax $ 815 $ 903
</TABLE>
F-17
<PAGE> 64
<TABLE>
<S> <C> <C>
Depreciation and amortization 5,000 12,407
Debt issue costs --- 732
------ ---------
5,815 14,042
------ ---------
Deferred Tax Assets:
Net operating loss 314 284
Accrued expenses 874 5,090
Reserve for bad debts 1,529 5,055
Inventory capitalization and reserves 2,094 1,633
Acquisition costs 278 277
------ ---------
5,089 12,339
------ ---------
Net deferred tax liabilities ($ 725) ($ 1,703)
====== =========
</TABLE>
For Federal tax purposes at December 31, 1999, the Company has
available approximately $491 of net operating loss carryforwards expiring from
2000 through 2007 and are subject to a limitation in their utilization of
approximately $149 per year as a result of several changes in shareholder
control.
NOTE J - DEFERRED COMPENSATION
In conjunction with the acquisition of J.E. Hanger, Inc. of Georgia
("JEH") in 1996, the Company assumed the unfunded deferred compensation plan
that had been established for certain key JEH officers. The plan accrues
benefits ratably over the period of active employment from the time the
contract is entered into to the time the participant retires. Participation had
been determined by JEH's Board of Directors. The Company has purchased
individual life insurance contracts with respect to each employee covered by
this plan. The Company is the owner and beneficiary of the insurance contracts.
The accrual related to the deferred compensation arrangements amounted to
approximately $2,248 and $2,106 at December 31, 1998 and 1999, respectively.
NOTE K - COMMITMENTS AND CONTINGENT LIABILITIES
The Company is subject to legal proceedings and claims which arise in
the ordinary course of its business, including claims related to alleged
contingent additional payments under business purchase agreements. Many of
these legal proceedings and claims existed in the NovaCare O&P business prior
to the Company's acquisition of NovaCare O&P. In the opinion of management, the
amount of ultimate liability, if any, with respect to these actions will not
have a materially adverse effect on the financial position, liquidity or
results of operations of the Company.
NOTE L - OPERATING LEASES
The Company leases office space under noncancellable operating
leases. Future minimum rental payments, by year and in the aggregate, under
operating leases with terms of one year or more consist of the following at
December 31, 1999:
F-18
<PAGE> 65
<TABLE>
<S> <C>
2000 $ 17,833
2001 13,683
2002 9,567
2003 6,954
2004 4,600
Thereafter 12,783
---------
$ 65,420
=========
</TABLE>
Rent expense was approximately $4,509, $6,283 and $14,821 for the
years ended December 31, 1997, 1998 and 1999, respectively.
NOTE M - PENSION AND PROFIT SHARING PLANS
Previously the Company had a separate defined contribution profit
sharing and 401(k) plan ("JEH Plan") covering all the employees of JEH, a
wholly-owned subsidiary of the Company acquired November 1, 1996. On this date,
the Company froze the JEH Plan such that no new employees of JEH were able to
participate. The Company did not incur any expense in connection with this plan
during 1997. On January 1, 1998 the JEH Plan was merged into the Company's
401(k) Savings and Retirement Plan.
Hanger acquired NovaCare O&P in July 1999. The NovaCare O&P employees
were allowed to participate in a 401(k) plan with NovaCare, Inc.
The NovaCare O&P employee assets were transferred to Hanger's 401(k)
fund manager in August 1999. The funds were transferred by executing a partial
plan merger. The NovaCare O&P employees were able to continue making 401(k)
contributions and were able to change their investment allocations.
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 and 1999, the Company made contributions of $583 and $923 to this
plan, respectively. The Company had not made any contributions to this plan in
1997.
NOTE N - REDEEMABLE PREFERRED STOCK
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.
During 1999, the Mandatorily Redeemable Preferred Stock Class F, of
which no shares had been issued, was retired. During 1999, in connection with
the acquisition of NovaCare O&P, the company issued $60,000 of 7% Redeemable
Preferred Stock accruing annual dividends, compounded quarterly equal to 7%,
and will be mandatorily redeemable on July 1, 2011 at the redemption price
equal to the $1,000 per share liquidation plus all accrued and unpaid
dividends. Such Preferred Stock is convertible into shares of the Company's
non-voting Common Stock at a price of $16.50 per share.
F-19
<PAGE> 66
NOTE O - WARRANTS AND OPTIONS
WARRANTS
In November 1990, the Company entered into a $2,450 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, 1999, 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"), 8,000,000 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 and
1999 was 679,751 and 4,454,751, respectively. Under the SOP, options may be
granted at an exercise price not less than the fair market value of the Common
Stock on the date of grant. Vesting and expiration periods are established by
the Compensation Committee of the Board of Directors and generally vest three
years following grant and generally expire eight to ten years after grant.
Under the Company's 1993 Non-Employee Director Stock Option Plan,
250,000 shares of Common Stock are authorized for issuance to directors of the
Company who are not employed by the Company or any affiliate of the Company.
Under this plan, an option to purchase 5,000 shares of Common Stock is granted
automatically on an annual basis to each eligible director on the third
business day following the date of each Annual Meeting of Stockholders of the
Company at which the eligible director is elected. The exercise price of each
option is equal to 100% of the fair market value of the Common Stock on the
date of grant. Each option vests at the rate of 25% each year for
F-20
<PAGE> 67
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, 1998 and 1999 were 60,000 and 25,000, 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 over the vesting period.
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>
Outstanding at
December 31, 1996 1,305,282 $ 2.75 to $12.25 5.54 191,250 $ 3.00 to $12.00 6.74
========= =======
</TABLE>
F-21
<PAGE> 68
<TABLE>
<S> <C> <C> <C> <C> <C>
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 $12.00 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
========= =======
Granted 1,225,000 $10.25 to $20.81 14.72 35,000 $ 10.25 to $20.81 14.70
Terminated (28,424) $ 4.13 to $22.50 13.01 (42,500) $ 3.00 to $18.63 6.92
Exercised (229,621) $ 2.75 to $13.25 6.94 (625) $ 6.52 to $ 6.52 6.52
Outstanding at
December 31, 1999 2,422,188 $ 2.75 to $22.50 12.57 160,750 $ 3.00 to $20.81 10.00
========= =======
Vested at December 31,
1999 976,590 85,750
========= =======
</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 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>
1997 1998 1999
---- ---- ----
<S> <C> <C> <C> <C>
Net Income: As reported $4,946 $13,840 $10,986
Pro Forma 4,010 12,433 7,731
Diluted Income Per
Common Share: As reported $.37 $.75 $.44
Pro Forma $.31 $.67 $.28
</TABLE>
The following is a summary of stock options exercisable at December
31, 1997, 1998 and 1999, and their respective weighted-average exercise prices:
<TABLE>
<CAPTION>
Weighted-Average
Number of Shares Exercise Price
---------------- ----------------
<S> <C> <C>
Options exercisable December 31, 1997 442,972 $5.66
Options exercisable December 31, 1998 560,703 $7.02
Options exercisable December 31, 1999 1,062,340 $9.66
</TABLE>
F-22
<PAGE> 69
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 1997, 1998 and 1999:
<TABLE>
<CAPTION>
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Expected term 5 5 5
Volatility factor 58% 59% 46%
Risk free interest rate 6.3% 5.1% 5.7%
Dividend yield 0 % 0 % 0 %
Fair value $4.99 $10.87 $7.00
</TABLE>
The following table summarizes information concerning outstanding and
exercisable options as of December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------- ------------------------------------
Weighted Average
Range of Exercise Number of Options ---------------- Number of Options Weighted Average
Prices and Awards Remaining Exercise Price and Awards Exercise Price
- ------------------- ----------------- Life (Years) -------------- ----------------- -----------------
------------
<S> <C> <C> <C> <C> <C>
$ 2.810 to $ 3.500 80,857 5.82 $ 3.16 55,857 $ 3.00
$ 4.125 to $ 4.125 41,840 6.22 $ 4.13 41,840 $ 4.13
$ 4.375 to $ 6.000 142,137 5.72 $ 5.87 110,150 $ 5.84
$ 6.125 to $ 6.125 396,733 6.88 $ 6.13 321,773 $ 6.13
$ 6.250 to $ 6.250 5,000 3.70 $ 6.25 5,000 $ 6.25
$ 8.500 to $ 8.750 28,334 7.42 $ 8.72 14,167 $ 8.72
$ 10.250 to $12.500 294,289 7.79 $11.39 172,938 $11.40
$ 13.250 to $13.875 120,875 7.88 $13.35 43,200 $13.34
$ 14.000 to $14.750 1,032,500 9.47 $14.30 240,000 $14.19
$ 16.500 to $18.625 266,333 9.14 $16.86 17,749 $17.87
$ 20.000 to $22.500 174,000 8.96 $22.19 39,666 $22.26
- ------------------- --------- ---- ------ --------- ------
$ 2.810 to $22.500 2,582,938 8.33 $12.41 1,062,340 $ 9.66
</TABLE>
NOTE P - SEGMENT AND RELATED INFORMATION
Using the guidelines set forth in SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information", the Company has identified
three reportable segments in which it operates based on the products and
services it provides. The Company evaluates segment performance and allocates
resources based on the segments' EBITDA. "EBITDA" is defined as income from
operations before depreciation and amortization. EBITDA is not a measure of
performance under Generally Accepted Accounting Principles ("GAAP"). While
EBITDA should not be considered in isolation or as a substitute for net income,
cash flows from operating activities and other income or
F-23
<PAGE> 70
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.
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>
1999
- ----
Net Sales
Customers $307,477 $10,263 $29,086 $ - $346,826
Intersegments 6,050 37,416 (43,466) ---
EBITDA 65,248 485 8,002 (9,628) 64,107
Total assets 142,462 15,689 16,296 575,634 750,081
</TABLE>
F-24
<PAGE> 71
<TABLE>
<S> <C> <C> <C> <C> <C>
Capital Expenditures 7,312 1,573 423 3,290 12,598
1998
- ----
Net Sales
Customers $152,276 $8,548 $27,046 --- $187,870
Intersegments --- 2,576 18,684 $(21,260) ---
EBITDA 32,351 433 4,174 (6,451) 30,507
Total assets 57,945 8,947 9,796 129,260 205,948
Capital Expenditures 1,698 576 232 353 2,859
1997
- ----
Net Sales
Customers $112,331 $7,698 $25,569 --- $145,598
Intersegments --- 1,452 14,026 $(15,478) ---
EBITDA 22,931 857 3,852 (5,153) 22,487
Total assets 46,619 8,826 107 102,431 157,983
Capital Expenditures 1,792 442 134 213 2,581
</TABLE>
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>
1999
- ----
EBITDA $65,248 $ 485 $8,002 $(9,628) $64,107
Restructuring Costs and
</TABLE>
F-25
<PAGE> 72
<TABLE>
<S> <C> <C> <C> <C> <C>
(5,763) (430) (60) (87) (6,340)
Integration Expense
Depreciation and (11,925) (1,640) (187) (306) (14,058)
Amortization
Interest expense, net (2,003) (17) (2) (20,155) (22,177)
Other income (expense) (153) (88) 6 (117) (352)
------- ------- ------ -------- -------
Income before taxes $45,404 $(1,690) $7,759 $(30,293) $21,180
======= ======= ====== ======== =======
1998
- ----
EBITDA $32,351 $ 433 $4,174 $ (6,451) $30,507
Depreciation and
Amortization (4,321) (1,009) (270) (182) (5,782)
Interest expense, net (1,538) (48) 6 (322) (1,902)
Other income
(expense) 507 (76) 475 (274) 633
------- ------- ------ -------- -------
Income $27,000 $ (700) $4,385 $ (7,229) $23,456
======= ======= ====== ======== =======
before taxes
1997
- ----
EBITDA $22,931 $ 857 $3,852 $ (5,153) $22,487
Depreciation and
Amortization (3,458) (726) (230) (267) (4,681)
Interest expense, net (3,200) (36) 5 (1,702) (4,933)
Other income (expense) 46 (78) 307 18 293
------- ------- ------ -------- -------
Income before taxes $16,319 $ 17 $3,934 $ (7,104) $13,166
======= ======= ====== ======== =======
</TABLE>
The following table presents the details of "Other" EBITDA for the years ended
December 31:
<TABLE>
<CAPTION>
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Corporate general and
administrative expenses $5,099 $6,399 $ 9,549
Other 54 52 79
------ ------ -------
$5,153 $6,451 $ 9,628
====== ====== =======
</TABLE>
The following table presents the details of "Other" total assets at December 31:
<TABLE>
<CAPTION>
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Corporate intercompany receivable from
Practice Management and Patient-Care $ 76,783 $ 93,713 $533,978
Centers segment
Corporate intercompany receivable from 5,386 20,217 16,277
Manufacturing segment
Corporate intercompany receivable from
</TABLE>
F-26
<PAGE> 73
<TABLE>
<S> <C> <C> <C>
Distribution segment 15,003 3,788 1,469
Other 5,259 11,542 ---
----------- ---------- --------
$ 102,431 $ 129,260 $551,724
=========== ========== ========
</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 1997, 1998 or 1999.
NOTE Q - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Summarized unaudited quarterly financial data for the years ended
December 31, 1998 and 1999 are:
<TABLE>
<CAPTION>
Quarter Ended
----------------------------------------------
1998 March 31 June 30 September 30 December 31
- ---- -------- ------- ------------ -----------
<S> <C> <C> <C> <C>
Net Sales $40,750 $46,900 $48,777 $51,444
Gross Profit 19,447 23,639 24,799 27,083
Net income 1,695 3,618 4,120 4,406
Diluted per common share data
- -----------------------------
Net income .10 .21 .22 .22
1999
- ----
Net Sales $49,145 $56,417 $124,922 $116,342
Gross Profit 24,256 28,862 65,344 59,287
Net income (loss) 3,121 4,875 3,449 (455)
Net income per common share-diluted (1) .15 .24 .12 (.08)
</TABLE>
(1) For the three months ended September 30, 1999, and the three months
ended December 31, 1999, excludes the effect of the conversion of Common Stock
into which shares of 7% Redeemable Preferred Stock are convertible as it is
considered anti-dilutive.
F-27
<PAGE> 74
================================================================================
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>
1999 Allowance for
doubtful
accounts $8,022 $15,046 $8,811 $14,013 $17,866
Inventory
Reserves $4,849 $ - $ 528 $ 3,096 $2,281
1998 Allowance for
doubtful
accounts $4,871 $7,510 $1,125 $5,484 $8,022
Inventory
Reserves $1,500 $2,202 $1,147 $ - 4,849
1997 Allowance for
doubtful
accounts $2,479 $5,613 $531 $3,752 4,871
Inventory
Reserves $ $1,160 $340 $ 1,500
</TABLE>
S-1
<PAGE> 1
Exhibit 23
Consent of Independent Accountants
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (File No. 33-63191) of Hanger Orthopedic Group, Inc. and
Subsidiaries of our reports dated March 29, 2000 relating to the financial
statements and financial statement schedule, which appears in this Form 10-K.
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
March 29, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 5,735
<SECURITIES> 0
<RECEIVABLES> 103,125
<ALLOWANCES> 17,866
<INVENTORY> 59,915
<CURRENT-ASSETS> 189,417
<PP&E> 61,373
<DEPRECIATION> 15,269
<TOTAL-ASSETS> 750,081
<CURRENT-LIABILITIES> 70,991
<BONDS> 426,211
0
59,225
<COMMON> 190
<OTHER-SE> 172,724
<TOTAL-LIABILITY-AND-EQUITY> 172,914
<SALES> 346,826
<TOTAL-REVENUES> 346,826
<CGS> 169,076
<TOTAL-COSTS> 134,041
<OTHER-EXPENSES> 352
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 22,177
<INCOME-PRETAX> 21,180
<INCOME-TAX> 10,194
<INCOME-CONTINUING> 10,986
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,986
<EPS-BASIC> $.47
<EPS-DILUTED> $.44
</TABLE>
