-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IY1fqCqqA81lLwer3VMJkYHQqnauoYVkRYYw/IPzLu5hHDaPBLcwz0fcC8U/KBMv i9iHWzVivoTqohDuFTOZPw== 0000897069-01-500375.txt : 20010815 0000897069-01-500375.hdr.sgml : 20010815 ACCESSION NUMBER: 0000897069-01-500375 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010630 FILED AS OF DATE: 20010814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HANGER ORTHOPEDIC GROUP INC CENTRAL INDEX KEY: 0000722723 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-SPECIALTY OUTPATIENT FACILITIES, NEC [8093] IRS NUMBER: 840904275 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-10670 FILM NUMBER: 1711582 BUSINESS ADDRESS: STREET 1: TWO BETHESDA METRO CENTER STREET 2: SUITE 1300 CITY: BETHESDA STATE: MD ZIP: 20814 BUSINESS PHONE: 3019860701 MAIL ADDRESS: STREET 1: TWO BETHESDA METRO CENTER STREET 2: SUITE 1300 CITY: BETHESDA STATE: MD ZIP: 20814 FORMER COMPANY: FORMER CONFORMED NAME: CELLTECH COMMUNICATIONS INC DATE OF NAME CHANGE: 19860304 FORMER COMPANY: FORMER CONFORMED NAME: SEQUEL CORP DATE OF NAME CHANGE: 19890814 10-Q 1 slp78a.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 ---------------------------------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------------- ---------------------- Commission file number 1-10670 HANGER ORTHOPEDIC GROUP, INC. ------------------------------ (Exact name of registrant as specified in its charter) Delaware 84-0904275 - -------------------------------------------------------------------------------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) Two Bethesda Metro Center, Suite 1200, Bethesda, MD 20814 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (301) 986-0701 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Former name, former address and former fiscal year, if changed since last report. Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No . --------------- --------------- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of August 10, 2001; 18,910,002 shares of common stock, $.01 par value per share. HANGER ORTHOPEDIC GROUP, INC. INDEX Page No. Part I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets - June 30, 2001 (unaudited) and December 31, 2000 1 Consolidated Statements of Operations for the three months ended June 30, 2001 and 2000 (unaudited) 3 Consolidated Statements of Operations for the six months ended June 30, 2001 and 2000 (unaudited) 4 Consolidated Statements of Cash Flows for the six months ended June 30, 2001 and 2000 (unaudited) 5 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 17 Item 3. Quantitative and Qualitative Disclosures About Market Risk 27 Part II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 28 SIGNATURES 29 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED BALANCE SHEETS (Dollars In Thousands, Except Shares and Per Share Amounts) June 30, December 31, 2001 2000 ----- ---- (unaudited) ASSETS CURRENT ASSETS Cash and cash equivalents $ 10,083 $ 20,669 Accounts receivable less allowances for doubtful accounts of $18,694 and $23,005 in 2001 and 2000, respectively 107,165 111,210 Inventories 49,499 61,223 Prepaid expenses and other assets 2,703 4,262 Income taxes receivable 12,680 6,325 Net assets held for sale 19,370 -- Deferred income taxes 20,416 20,038 -------- -------- Total current assets 221,916 223,727 -------- -------- PROPERTY, PLANT AND EQUIPMENT Land 4,177 4,177 Buildings 9,071 8,876 Machinery and equipment 27,362 31,393 Furniture and fixtures 9,841 9,968 Leasehold improvements 17,284 16,925 -------- -------- 67,735 71,339 Less accumulated depreciation and amortization 27,003 24,345 -------- -------- 40,732 46,994 -------- -------- INTANGIBLE ASSETS Excess of cost over net assets acquired 472,806 490,724 Non-compete agreements 1,103 1,426 Patents 8,100 9,924 Assembled work force 7,000 7,000 Debt issuance costs 16,977 15,917 Other intangible assets 1,125 1,165 -------- -------- 507,111 526,156 Less accumulated amortization 40,484 36,533 -------- -------- 466,627 489,623 -------- -------- OTHER ASSETS 1,199 1,474 -------- -------- TOTAL ASSETS $730,474 $761,818 ======== ======== The accompanying notes are an integral part of the consolidated financial statements. 1 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED BALANCE SHEETS (Dollars In Thousands, Except Shares and Per Share Amounts)
June 30, December 31, 2001 2000 ---- ---- (unaudited) LIABILITIES, REDEEMABLE PREFERRED STOCK & SHAREHOLDERS' EQUITY CURRENT LIABILITIES Current portion of long-term debt $ 32,901 $ 37,595 Accounts payable 13,961 17,809 Accrued expenses 7,715 9,380 Accrued interest payable 3,284 7,559 Accrued wages and payroll taxes 13,877 17,385 Deferred revenue 92 309 --------- --------- Total current liabilities 71,830 90,037 --------- --------- Long-term debt 411,313 422,838 Deferred income taxes 27,349 26,026 Other liabilities 4,330 2,656 7% Redeemable Preferred Stock, liquidation preference of $1,000 per share 68,269 65,881 SHAREHOLDERS' EQUITY Common stock, $.01 par value; 60,000,000 shares authorized, 18,910,002 shares and 18,910,002 shares issued and outstanding in 2001 and 2000 190 190 Additional paid-in capital 146,498 146,498 Retained earnings 1,351 8,348 --------- --------- 148,039 155,036 Treasury stock, at cost (133,495 shares) (656) (656) --------- --------- 147,383 154,380 --------- --------- TOTAL LIABILITIES, REDEEMABLE PREFERRED STOCK & SHAREHOLDERS' EQUITY $ 730,474 $ 761,818 ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 2 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATION FOR THE THREE MONTHS ENDED June 30, 2001 and 2000 (Dollars In Thousands, Except Shares and Per Share Amounts) (unaudited)
2001 2000 ---- ---- Net sales $ 129,187 $ 125,872 Cost of products and services sold 63,434 60,310 ------------ ------------ Gross profit 65,753 65,562 Selling, general & administrative expenses 44,137 42,833 Depreciation and amortization 3,334 2,939 Amortization of excess cost over net assets acquired 3,073 2,796 Restructuring and asset impairment costs 3,688 -- Integration costs -- 502 Impairment loss on assets held for sale 8,176 -- ------------ ------------ Income from operations 3,345 16,492 Other (expense) income: Interest expense, net (11,033) (10,951) Other, net 39 (31) ------------ ------------ Income (loss) before income taxes (7,649) 5,510 ------------ ------------ Provision (benefit) for income taxes (2,908) 3,103 ------------ ------------ Net income (loss) $ (4,741) $ 2,407 ============ ============ Net income (loss) applicable to common stock $ (5,945) $ 1,241 ============ ============ Basic Per Common Share Data Net income (loss) $ (.31) $ .06 ============ ============ Shares used to compute basic per common share amounts 18,910,002 18,910,002 ============ ============ Diluted Per Common Share Data Net income (loss) $ (.31) $ .06 ============ ============ Shares used to compute diluted per common share Amounts (1) 18,910,002 19,154,415 ============ ============ (1) Excludes the effect of the conversion of the 7% Redeemable Preferred Stock into common stock as it is anti-dilutive. All other outstanding options and warrants are anti-dilutive due to the net loss available to the Company's common shareholders for the six months ended June 30, 2001 and 2000, and the three months ended June 30, 2001.
The accompanying notes are an integral part of the consolidated financial statements. 3 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATION FOR THE SIX MONTHS ENDED June 30, 2001 and 2000 (Dollars In Thousands, Except Shares and Per Share Amounts) (unaudited)
2001 2000 ---- ---- Net sales $ 249,760 $ 240,740 Cost of products and services sold 126,408 117,494 ------------ ------------ Gross profit 123,352 123,246 Selling, general & administrative expenses 88,442 82,008 Depreciation and amortization 6,392 5,656 Amortization of excess cost over net assets acquired 6,119 5,787 Restructuring and asset impairment costs 3,688 -- Integration costs -- 1,088 Impairment loss on assets held for sale 8,176 -- ------------ ------------ Income from operations 10,535 28,707 Other expense: Interest expense, net (23,291) (22,109) Other, net 140 (33) ------------ ------------ Income (loss) before income taxes (12,616) 6,565 Provision (benefit) for income taxes (8,007) 4,438 ------------ ------------ Net income (loss) $ (4,609) $ 2,127 ============ ============ Net income (loss) applicable to common stock $ (6,997) $ (177) ============ ============ Basic Per Common Share Data Net loss $ (.37) $ (.01) ============ ============ Shares used to compute basic per common share amounts 18,910,002 18,910,002 ============ ============ Diluted Per Common Share Data Net loss $ (.37) $ (.01) ============ ============ Shares used to compute diluted per common share amounts * 18,910,002 18,910,002 ============ ============ * Excludes the effect of the conversion of common stock into which shares of 7% Redeemable Preferred Stock are convertible as it is anti-dilutive. All other outstanding options and warrants are anti-dilutive due to the net loss for the Company for the six months ended June 30, 2001 and 2000 and the three months ended June 30, 2001.
The accompanying notes are an integral part of the consolidated financial statements. 4 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED June 30, 2001 and 2000 (Dollars In Thousands) (unaudited) 2001 2000 ---- ---- Cash flows from operating activities: Net income (loss) $ (4,609) $ 2,127 -------- -------- Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Impairment loss on assets held for sale 8,176 -- Provision for bad debts 10,628 8,106 Deferred income taxes 945 3,653 Depreciation and amortization 6,392 5,656 Amortization of excess cost over net assets acquired 6,119 5,787 Amortization of debt issuance costs 1,273 965 Restructuring costs 3,688 -- Changes in assets and liabilities, net of effect from acquired companies: Accounts receivable (8,420) (17,080) Inventories 8,088 (7,913) Prepaid expenses and other assets (5,172) (3,769) Other assets 234 146 Accounts payable (3,880) 1,797 Accrued expenses (9,070) 1,286 Accrued wages and payroll taxes (3,295) (6,794) Other liabilities 1,635 (222) -------- -------- Total adjustments 17,341 (8,382) -------- -------- Net cash provided by (used in) operating activities 12,732 (6,255) -------- -------- Cash flows from investing activities: Purchase of fixed assets (3,257) (5,934) Acquisitions/earn-outs, net of cash acquired (2,783) (4,550) Cash received pursuant to purchase price adjustment -- 15,000 -------- -------- Net cash provided by (used in) investing activities (6,040) 4,516 -------- -------- Continued The accompanying notes are an integral part of the consolidated financial statements. 5 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED June 30, 2001 and 2000 (Dollars In Thousands) (unaudited) 2001 2000 ---- ---- Cash flows from financing activities: Borrowings under revolving credit facility $ 4,000 $ 13,400 Repayment of term loans (13,250) (5,500) Repayment of long-term debt (6,969) (7,352) Increase in financing costs (1,059) (1,255) -------- -------- Net cash used in financing activities (17,278) (707) -------- -------- Net change in cash and cash equivalents for the period (10,586) (2,446) Cash and cash equivalents at beginning of period 20,669 5,735 -------- -------- Cash and cash equivalents at end of period $ 10,083 $ 3,289 ======== ======== Supplemental disclosure of cash flow information: Cash paid during the period for: Interest $ 27,518 $ 19,373 ======== ======== Taxes $ 375 $ 2,137 ======== ======== Non-cash financing and investing activities: Issuance of notes in connection with acquisitions $ -- $ 924 ======== ======== Dividends declared on preferred stock $ 2,351 $ 2,267 ======== ======== Accretion of preferred stock $ 37 $ 37 ======== ======== Notes received pursuant to purchase price adjustment $ -- $ 9,700 ======== ======== The accompanying notes are an integral part of the consolidated financial statements. 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ (Dollars In Thousands, Except Shares and Per Share Amounts) NOTE A -- BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with Rule 10-01 of Regulation S-X. They do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting of a normal recurring nature, considered necessary for a fair presentation have been included. The Company uses the gross profit method to value inventory on an interim basis. These financial statements should be read in conjunction with the financial statements of Hanger Orthopedic Group, Inc. (the "Company") and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2000 filed by the Company with the Securities and Exchange Commission. NOTE B - SEGMENT AND RELATED INFORMATION The Company evaluates segment performance and allocates resources based on the segments' EBITDA. "EBITDA" is defined as income from operations before depreciation, amortization restructuring, integration and impairment loss on the sale of assets. The Company's calculation of EBITDA may differ from other corporations. EBITDA is not a measure of performance under Generally Accepted Accounting Principles ("GAAP"). While EBITDA should not be considered in isolation or as a substitute for net income, cash flows from operating activities and other income or cash flow statement data prepared in accordance with GAAP, or as a measure of profitability or liquidity, management understands that EBITDA is customarily used as a criteria in evaluating heath care companies. Moreover, substantially all of the Company's financing agreements contain covenants in which EBITDA is used as a measure of financial performance. EBITDA is presented for each reported segment before reclassifications between EBITDA and other income (expense) made for external reporting purposes. "Other" EBITDA not directly attributable to reportable segments is primarily related to corporate general and administrative expenses. In anticipation of the sale of the manufacturing segment, the Company moved the reporting of the Sea-Fabs business to the patient care segment. The 2000 data has been restated to be consistent with 2001 reporting in that the Sea-Fabs activity was moved from manufacturing to patient care. 7 Summarized financial information concerning the Company's reportable segments is shown in the following table:
Practice Management Other And Patient and Care Centers Manufacturing Distribution Eliminations Total Three Months Ended June 30, 2001 Net Sales Customers $ 119,988 $ 1,634 $ 7,565 $ -- $ 129,187 ========= ========= ========= ========= ========= Intersegments $ -- $ 1,149 $ 13,945 $ (15,094) $ -- ========= ========= ========= ========= ========= EBITDA $ 26,792 $ (41) $ 1,718 $ (6,853) $ 21,616 Restructuring costs and integration expense (3,604) (84) -- -- (3,688) Depreciation and amortization (5,346) (438) (110) (513) (6,407) Interest expense, net (12,632) (237) -- 1,836 (11,033) Other income (expense) (18) 33 1 23 39 Impairment loss on assets held for sale -- (8,176) -- -- (8,176) --------- --------- --------- --------- --------- Income (loss) before taxes $ 5,192 $ (8,943) $ 1,609 $ (5,507) $ (7,649) ========= ========= ========= ========= ========= Three Months Ended June 30, 2000 * Net Sales Customers $ 116,004 $ 2,598 $ 7,270 $ -- $ 125,872 ========= ========= ========= ========= ========= Intersegments $ 2,273 $ 1,784 $ 12,951 $ (17,008) $ -- ========= ========= ========= ========= ========= EBITDA $ 26,203 $ 196 $ 1,816 $ (5,486) $ 22,729 Restructuring costs and integration expense (257) -- -- (245) (502) Depreciation and amortization (4,880) (508) (101) (246) (5,735) Interest expense, net (24,345) (4) -- 13,398 (10,951) Other (income) expense -- 7 (38) -- (31) --------- --------- --------- --------- --------- Income (loss) before taxes $ (3,279) $ (309) $ 1,677 $ 7,421 $ 5,510 ========= ========= ========= ========= ========= * Included the transfer of Sea-Fabs in 2000 from the manufacturing to the patient care segments to be consistent with 2001 reporting.
8
Practice Management Other And Patient and Care Centers Manufacturing Distribution Eliminations Total Six Months Ended June 30, 2001 Net Sales Customers $ 231,034 $ 3,214 $ 15,512 $ -- $ 249,760 ========= ========= ========= ========= ========= Intersegments $ -- $ 2,239 $ 26,720 $ (28,959) $ -- ========= ========= ========= ========= ========= EBITDA $ 45,187 $ 162 $ 3,272 $ (13,711) $ 34,910 Restructuring costs and integration expense (3,604) (84) -- -- (3,688) Depreciation and amortization (10,623) (854) (219) (815) (12,511) Interest expense, net (25,341) (254) -- 2,304 (23,291) Other income (expense) (6) 62 3 81 140 Impairment loss on assets held for sale -- (8,176) -- -- (8,176) --------- --------- --------- --------- --------- Income (loss) before taxes $ 5,613 $ (9,144) $ 3,056 $ (12,141) $ (12,616) ========= ========= ========= ========= ========= Six Months Ended June 30, 2000 * Net Sales Customers $ 221,459 $ 4,990 $ 14,291 $ -- $ 240,740 ========= ========= ========= ========= ========= Intersegments $ 4,817 $ 2,807 $ 26,523 $ (34,147) $ -- ========= ========= ========= ========= ========= EBITDA $ 47,962 $ 448 $ 3,716 $ (10,888) $ 41,238 Restructuring costs and integration expense (747) -- (6) (335) (1,088) Depreciation and amortization (10,115) (705) (152) (471) (11,443) Interest expense, net (25,047) (7) -- 2,945 (22,109) Other expense (52) 20 (1) -- (33) --------- --------- --------- --------- --------- Income (loss) before taxes $ 12,001 $ (244) $ 3,557 $ (8,749) $ 6,565 ========= ========= ========= ========= ========= * Included the transfer of Sea-Fabs in 2000 from the manufacturing to the patient care segments to be consistent with 2001 reporting.
9 NOTE C -- INVENTORY Inventories at June 30, 2001 and December 31, 2000 were comprised of the following: June 30, 2001 December 31, 2000 ------------- ----------------- (unaudited) Raw materials $21,295 $29,482 Work-in-process 19,829 19,885 Finished goods 8,375 11,856 --------- -------- $49,499 $61,223 ========= ======== NOTE D - ACQUISITIONS During 2000, the Company acquired five orthotic and prosthetic companies. The aggregate purchase price, excluding potential earn-out provisions, was $4,500, comprised of $2,400 in cash and $2,100 in promissory notes. The notes are payable over two to five years with interest rates ranging from 6% to 8%. The cash portion of the purchase price for these acquisitions was borrowed under the Company's revolving credit facility. The Company has not acquired any companies during 2001. Additionally, the Company paid, during the six-month period ending June 30, 2001, approximately $2,783 related to orthotic and prosthetic companies acquired in years prior to 2001. 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 $2,783. Additional amounts aggregating approximately $8,300 may be paid in connection with earnout provisions contained in previous acquisition agreements. NOTE E - INTEGRATION, RESTRUCTURING, & ASSET IMPAIRMENT COSTS In connection with the acquisition of NovaCare Orthotics & Prosthetics, Inc. ("NovaCare O&P") on July 1, 1999, the Company implemented a restructuring plan as of that date. The plan contemplated lease termination and severance costs associated with the closure of certain redundant patient-care centers and corporate functions of the Company and NovaCare O&P. The costs associated with the former NovaCare O&P centers were recorded in connection with the purchase price allocation on July 1, 1999. The costs associated with the existing Company centers were charged to operations during the third quarter of 1999. As of December 31, 2000, the reduction in work force had been completed and the patient care centers identified for closure, closed. Lease payments on closed patient care centers identified are expected to be paid through 2003. As of June 30, 2001, management reversed $771 of the lease termination restructuring reserve. This benefit resulted from favorable lease buyouts and sublease activity. 10 In December of 2000, management and the Board of Directors determined that major performance improvement initiatives needed to be adopted. Two hundred thirty-four (234) employees were severed in an effort to reduce general and administrative costs and the Company retained Jay Alix & Associates ("JA&A") to do an assessment of the opportunities available for improved financial and operating performance. As of December 31, 2000, the Company recorded approximately $700 in restructuring liabilities. These amounts were paid in January of 2001. Upon their retention, JA&A began the development of a comprehensive performance improvement program which consists of fourteen performance improvement initiatives aimed at improving cash collections, reducing working capital requirements and improving operating performance. In connection with the implementation of the JA&A initiatives, the Company recorded in the second quarter approximately $3,688 in restructuring and asset impairment costs ($4,459 expense offset by above mentioned $771 benefit). The plan calls for the closure of 37 facilities and the termination of approximately 135 additional employees. As of June 30, 2001, 32 of the facilities have been vacated and 30 of the employees have been terminated. Actions under this plan are expected to be completed by December 31, 2001. Payments under the plan for lease and severance costs are expected to be paid by December 31, 2003. Components of the restructuring reserves, spending during the year, and the remaining reserve balance are as follows: Lease Employee Termination Total Severance and Other Restructuring Costs Exit Costs Reserve ----------- ----------- -------------- Balance at December 31, 2000 $ 693 $ 1,407 $ 2,100 Spending (693) (93) (786) Amendment to plan -- (771) (771) ------- ------- ------- Balance of 1999 and 2000 restructuring reserves at June 30, 2001 $ -- $ 543 $ 543 Second quarter 2001 restructuring charge 1,208 3,251* 4,459 Spending (198) (346) (544) ------- ------- ------- Balance of 2001 restructuring reserve at June 30, 2001 $ 1,010 $ 2,905 $ 3,915 ------- ------- ------- Total restructuring reserve balance at June 30, 2001 $ 1,010 $ 3,448 $ 4,458 ======= ======= ======= * Includes $484 of asset impairment for impaired leasehold improvements at branches to be vacated. 11 NOTE F - AGREEMENT WITH JAY ALIX & ASSOCIATES On December 11, 2000, the Company retained the services of JA&A to assist in identifying areas for cash generation and profit improvement. Subsequent to the completion of this diagnostic phase, the Company modified and extended the retention agreement on January 23, 2001 to include the implementation of certain restructuring activities. Among the targeted plans are spending reductions, improving the utilization and effectiveness of support services, including claims processing, the refinement of materials purchasing and inventory management and the consolidation of distribution services. In addition, the Company will seek to enhance revenues through improved marketing efforts and more efficient billing procedures. The terms of this engagement provide for payment of JA&A's normal hourly fees plus a success fee if certain defined benefits are achieved. Management has elected to pay one-half of any earned success fee in cash, with the remaining one-half of the success fee paid through a grant of options to purchase the Company's common stock. All the options will be granted with an exercise price of $1.40 per share, which was the average closing price of the Company's common stock for all trading days during the period from December 23, 2000 through January 23, 2001. The number of options will be determined by multiplying the non-cash half of each success fee invoice of JA&A by 1.5 and dividing the product by $1.40. The options are to be granted within thirty (30) days of each invoice, shall be exercisable beginning with the sixth month following each award and shall expire five years from the termination of JA&A's engagement. The number of options that will be granted cannot be determined at this time. As of June 30, 2001, none of the initiatives for which defined benefits may be measured and a success fee earned have been completed and therefore no options have been granted or cash payments accrued. 12 NOTE G - NET INCOME PER COMMON SHARE The following sets forth the calculation of the basic and diluted income per common share amounts for the six-month periods ended June 30, 2001 and 2000.
Three Months Ended Six Months Ended June 30, June 30, ------------------------------- ------------------------------- 2001 2000 2001 2000 ---- ---- ---- ---- Net income (loss) $ (4,741) $ 2,407 $ (4,609) $ 2,127 Less preferred stock accretion and dividends declared (1,204) (1,181) (2,388) (2,304) ------------ ------------ ------------ ------------ Income (loss) available to common stockholders used to compute basic per common (5,945) 1,226 (6,997) (177) share amounts Add back interest expense on convertible note payable, net of tax * -- 15 -- -- ------------ ------------ ------------ ------------ Income (loss) available to common stockholders plus assumed conversions used to compute diluted per common share amounts * $ (5,945) $ 1,241 $ (6,997) $ (177) ============ ============ ============ ============ Average shares of common stock outstanding used to compute basic per common share amounts 18,910,002 18,910,002 18,910,002 18,910,002 Effect of convertible note payable * -- 69,430 -- -- Effect of dilutive options * -- 103,140 -- -- Effect of dilutive warrants * -- 71,843 -- -- ------------ ------------ ------------ ------------ Shares used to compute dilutive per common share amounts * 18,910,002 19,154,415 18,910,002 18,910,002 ============ ============ ============ ============ Basic income (loss) per common share $ ( .31) $ .06 $ (.37) $ (.01) Diluted income (loss) per common share $ ( .31) $ .06 $ (.37) $ (.01) * Excludes the effect of the conversion of the 7% Redeemable Preferred Stock into common stock as it is anti-dilutive. All other outstanding options and warrants are anti-dilutive due to the net loss available to the Company's common shareholders for the six months ended June 30, 2001 and 2000 and the three months ended June 30, 2001.
NOTE H - LONG TERM DEBT The Company's total long term debt at June 30, 2001, including a current portion of $32,901, was $444,214. Such indebtedness included: (i) $150,000 senior subordinated notes; (ii) $88,700 for the revolver; (iii) $80,000 for Tranche A; (iv) $98,500 for Tranche B; and (v) a total of $27,014 of other indebtedness. In addition at December 31, 2000, the Company was not in compliance with the financial covenants under the Credit Agreement for interest coverage and leverage coverage. In consideration for the bank's waiver of the Company's non-compliance with these covenants, an 13 amendment to the amended and restated Credit Agreement dated as of March 16, 2001, was entered into which provides for an increase in the Tranche A Term Facility and the Revolving Credit Facility annual interest rate to adjusted London Interbank Offering Rate ("LIBOR") plus 3.50% or Alternate Borrowing Rate ("ABR") plus 2.50%., and an increase in the Tranche B Term Facility annual interest rate to adjusted LIBOR plus 4.50% or ABR plus 3.50%. Certain of the financial covenants were eased with respect to 2001 and 2002 under the terms of the amendment to the Credit Agreement. As of June 30, 2001, the Company was in compliance with all of its financial covenants. Matters critical to the Company's compliance with the Credit Facility's covenants, and ultimately its immediate term liquidity (to the extent alternative sources of liquidity are not readily available), include improving operating results, through revenue growth and cost control, and reducing the Company's investment in working capital. The Company's ability to continue to comply with the Credit Facility covenants is dependent on certain factors, including (a) the ability of the Company to effect the restructuring initiatives referred to above, and (b) the Company's ability to continue to attract and retain experienced management and O&P practitioners. Unexpected increases in LIBOR could also adversely impact the Company's ability to comply with the Credit Facility's convenants. The Credit Facility with the Bank is collateralized by substantially all the assets of the Company, restricts payments of dividends, and contains certain affirmative and negative covenants customary in an agreement of this nature. NOTE I - COMMITMENTS AND CONTINGENCIES The Company is subject to legal proceedings and claims which arise in the ordinary course of its business, including claims related to alleged contingent additional payments under business purchase agreements. Many of these legal proceedings and claims existed in the NovaCare O&P business prior to the Company's acquisition of NovaCare O&P. In the opinion of management, the amount of ultimate liability, if any, with respect to these actions will not have a materially adverse effect on the financial position, liquidity or results of operations of the Company. On November 28, 2000, a class action complaint (Norman Ottmann v. Hanger Orthopedic Group, Inc., Ivan R. Sabel and Richard A. Stein; Civil Action No. 00CV3508) was filed against the Company in the United States District Court for the District of Maryland on behalf of all purchasers of our common stock from November 8, 1999 through and including January 6, 2000. The complaint also names as defendants Ivan R. Sabel, Chairman of the Board, President and Chief Executive Officer of the Company, and Richard A. Stein, former Chief Financial Officer, Secretary and Treasurer of the Company. The complaint alleges that during the above period of time, the defendants violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934 by, among other things, knowingly or recklessly making material misrepresentations concerning the Company's financial results for the quarter ended September 30, 1999, and the progress of the Company's efforts to integrate the recently-acquired operations of NovaCare O&P. The complaint further alleges that by making those material 14 misrepresentations, the defendants artificially inflated the price of the Company's common stock. The plaintiff seeks to recover damages on behalf of all of the class members. The Company believes that the allegations are without merit and plan to vigorously defend the lawsuit. NOTE J - NEW ACCOUNTING STANDARDS On June 29, 2001, the FASB unanimously approved its proposed Statements of Financial Accounting Standards No. 141 (SFAS 141), Business Combinations, and No. 142 (SFAS 142), Goodwill and Other Intangible Assets. SFAS 141 supercedes Accounting Principles Board (APB) Opinion No. 16, Business Combinations. The most significant changes made by SFAS 141 are: (1) requiring that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, (2) establishing specific criteria for the recognition of intangible assets separately from goodwill, and (3) requiring unallocated negative goodwill to be written off immediately as an extraordinary gain rather than being deferred and amortized. The Company does not expect a material impact from the adoption of SFAS 141 on our consolidated financial statements. SFAS 142 supercedes APB 17, Intangible Assets. SFAS 142 primarily addresses accounting for goodwill and intangible assets subsequent to their acquisition (i.e., the post-acquisition accounting). The provisions of SFAS 142 will be effective for fiscal years beginning after December 15, 2001. However, early adoption of SFAS 142 will be permitted for companies with a fiscal year beginning after March 15, 2001, provided their first quarter financial statements have not been previously issued. In all cases, SFAS 142 must be adopted at the beginning of a fiscal year. The most significant changes made by SFAS 142 are: (1) goodwill and indefinite lived intangible assets will no longer be amortized, (2) goodwill will be tested for impairment at least annually at the reporting unit level, (3) intangible assets deemed to have an indefinite life will be tested for impairment at least annually, and (4) the amortization period of intangible assets with finite lives will no longer be limited to forty years. The Company intends to adopt SFAS 142 effective January 1, 2002 and is currently evaluating the impact on our consolidated financial statements. NOTE K - SUBSEQUENT EVENTS On August 10, 2001, the Board of Directors authorized the sale of substantially all of the manufacturing related assets of Seattle Orthopedic Group, Inc. ("SOGI"). After review and analysis, the Company determined that the manufacture of orthotic and prosthetic devices was not a core business of the Company since such manufacturing activity represents only 1% of the Company's revenue for the six months ended June 30, 2001 and 2% of revenue for the year ended December 31, 2000. The sale of SOGI's manufacturing assets is expected to be completed by August 31, 2001 and such assets as of June 30, 2001 have a net carrying value of $19,370. The Company recorded an impairment loss of $8,176 on the planned disposal of SOGI's manufacturing assets which has been reflected in the Company's statement of operations. Amendment No. 2 to the Amended and Restated Credit Agreement provides the Company with the ability to retain up to $5,000 or the proceeds from 15 the sale of SOGI for working capital purposes. These proceeds will only be retained by the Company for a specified period of time. The proceeds will then be applied to the term loans in accordance with the Credit Agreement. For the six months ended June 30, 2001, the results of operations of SOGI's manufacturing activities, including intercompany transactions during that same period were: (In thousands) Sales $5,453 Cost of Sales 3,475 Gross Profit 1,978 SG&A 1,816 Restructuring 84 Operating Margin 78 Reconciliation of SOGI Transaction Accounts Receivable $ 1,542 Inventory 3,635 Net Fixed Assets 4,208 Net Intangibles 18,863 Other 86 Liabilities Assumed (788) ------- Net Book Value 27,546 Estimated Proceeds for Net Assets Held for sale 19,370 ------- Impairment loss on assets held for sale (8,176) ======= 16 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations The following table sets forth for the periods indicated certain items of the Company's Statements of Operation and their percentage of the Company's net sales:
Three Months Six Months Ended June 30, Ended June 30, -------------- -------------- 2001 2000 2001 2000 ---- ---- ---- ---- Net sales 100.0% 100.0% 100.0% 100.0% Cost of products and services sold 49.1 47.9 50.6 48.8 Gross profit 50.9 52.1 49.4 51.2 Selling, general & administrative expenses 34.2 34.0 35.4 34.1 Depreciation and amortization 2.6 2.3 2.6 2.3 Amortization of excess cost over net assets acquired 2.4 2.2 2.4 2.4 Restructuring and Asset Impairment Costs 2.8 -- 1.5 -- Integration costs -- 0.4 -- 0.5 Impairment loss on assets held for sale 6.3 -- 3.3 -- Income from operations 2.6 13.1 4.2 11.9 Interest expense, net (8.5) 8.7 9.3 9.2 Provision for income taxes (2.3) 2.5 (3.2) 1.8 Net income (loss) (3.7) 1.9 (1.8) 0.9
Three Months Ended June 30, 2001 Compared to the Three Months Ended June 30, 2000 Net Sales Net sales for the quarter ended June 30, 2001, were approximately $129.2 million, an increase of approximately $3.3 million, or 2.6%, over net sales of approximately $125.9 million for the quarter ended June 30, 2000. Contributing to the increase were (i) the acquisitions completed during 2000 and (ii) a 2.6% increase in sales by patient care centers operating during both quarters ("same store sales"). Gross Profit Gross profit in the quarter ended June 30, 2001 was approximately $65.8 million, an increase of approximately $0.2 million, or 0.3%, from gross profit of approximately $65.6 million for the quarter ended June 30, 2000. The increase was primarily attributable to higher sales offset by higher cost of materials and changes in the product mix. Gross profit as a percentage of net sales decreased to 50.9% in the second quarter of 2001 from 52.1% in the second quarter of 2000. 17 Selling, General and Administrative Expenses Selling, general and administrative expenses in the quarter ended June 30, 2001 increased $1.3 million, or 3.0%, compared to the quarter ended June 30, 2000. The increase in selling, general and administrative expenses was primarily the result of an increase in the bad debt expense, higher rent, and performance compensation based on accounts receivable collections. Selling, general and administrative expenses as a percentage of net sales increased to 34.2% in the second quarter of 2001 compared to 34.0% for the same period in 2000. Restructuring and Asset Impairment Costs During the second quarter of 2001, the Company established a restructuring reserve totaling $3.7 million. These amounts will be paid by December 31, 2002 and consist of severance costs, lease and other exit costs. See discussion later in the management discussion and analysis. Impairment on Assets Held for Sale On August 10, 2001, the Board of Directors authorized the sale of substantially all of the manufacturing related assets of Seattle Orthopedic Group, Inc. (SOGI). After extensive review and analysis, the Company determined that the manufacture of orthotic and prosthetic components and devices was not a core business of Hanger representing only 1% of Hanger's revenue for the six months ended June 30, 2001 and 2% for the year ended December 31, 2000. The Company believes that its assets and management expertise can be more effectively deployed in its core business providing our orthotic and prosthetic patients with clinical excellence and superior customer service. The provision of treatment and service to orthotic and prosthetic patients represented 92.5% of Hanger's revenues for the six months ended June 30, 2001 and 92.1% of revenues for the year ended December 31, 2000. The sale of SOGI's manufacturing assets is expected to be completed by August 31, 2001 and such assets as of June 30, 2001 have a net carrying value of $19.37 million. The Company recorded an impairment loss of $8.176 million on the planned disposal of SOGI's manufacturing assets which has been reflected in the Company's statement of operations. Amendment No. 2 to the Amended and Restated Credit Agreement provides the Company with the ability to retain up to $5 million or the proceeds from the sale of SOGI for working capital purposes. These proceeds will only be retained by the Company for a specified period of time. The proceeds will then be applied to the term loans in accordance with the Credit Agreement. Income from Operations Principally as a result of the above, income from operations in the quarter ended June 30, 2001 was approximately $3.3 million, a decrease of $13.1 million, or 79.7%, below the prior year's comparable quarter. Income from operations as a percentage of net sales decreased to 2.6% in the second quarter of 2001 from 13.1% for the prior year's comparable period. 18 Interest Expense, Net Net interest expense in the second quarter of 2001 was approximately $11.0 million, an increase of approximately $0.1 million over the approximately $10.9 million incurred in the second quarter of 2000. The increase in interest expense was primarily attributable to a $2.7 million increase in average borrowings during the second quarter of 2001 compared to the second quarter of 2000 and a 50 basis point increase in the LIBOR Adder as a result of the March 16, 2001 Amendment to the Credit Agreement which was partially offset by a reduction in LIBOR. Interest expense as a percentage of net sales decreased to 8.5% from 8.7% for the same period a year ago. Income Taxes The Company's effective tax rate was (38.0%) in the second quarter of 2001 versus 56.3% in 2000. The Company's calculation of its effective tax rate is based on its projected annual earnings as adjusted for routine non-deductible items. The sale of SOGI represents a discrete event and a separate tax benefit was calculated for this event with an effective rate of 42%. Continuing operations were taxed based upon the Company's effective rate of 100.8% as calculated using projected income amounts for the fiscal year. The decrease in the effective tax rate in the second quarter of 2001 versus 2000 is the result of the decrease in projected annual earnings in relation to nondeductible items, primarily attributable to the July 1, 1999 acquisition of NovaCare O&P. The benefit for income taxes in the second quarter of 2001 was approximately $2.9 million compared to the provision of $3.1 million for the second quarter of 2000. Net Income (Loss) As a result of the above, the Company recorded a net loss of $4.7 million, or $.31 loss per dilutive common share, in the quarter ended June 30, 2001, compared to a net income of $2.4 million, or $.06 per dilutive common share, in the quarter ended June 30, 2000. Six Months Ended June 30, 2001 Compared to the Six Months Ended June 30, 2000 Net Sales Net sales for the six months ended June 30, 2001, were approximately $249.8 million, an increase of approximately $9.0 million, or 3.7%, over net sales of approximately $240.7 million for the six months ended June 30, 2000. Contributing to the increase were (i) the acquisitions completed during 2000 and (ii) a 3.8% increase in sales by patient care centers operating during both periods ("same store sales"). Gross Profit Gross profit in the six months ended June 30, 2001 was approximately $123.4 million, an increase of approximately $0.1 million, or 0.1%, from gross profit of approximately $123.2 million for the six months ended June 30, 2000. The increase was primarily attributable to higher sales during the period offset by higher cost of materials and changes in the product mix. Gross profit as 19 a percentage of net sales decreased to 49.4% in the first six months of 2001 from 51.2% in the first six months of 2000. Selling, General and Administrative Expenses Selling, general and administrative expenses in the six months ended June 30, 2001 increased by $6.4 million, or 7.8%, compared to the six months ended June 30, 2000. Selling, general and administrative expenses as a percentage of net sales increased to 35.4% in the second quarter of 2001 compared to 34.1% for same period in 2000. The increase in selling, general and administrative expenses was primarily the result of an increase in the bad debt expense, higher rent, and performance compensation based on accounts receivable collection. Restructuring and Asset Impairment Costs During the second quarter of 2001, the Company established a restructuring reserve totaling $3.7 million. These amounts will be paid by December 31, 2002 and consist of severance costs, lease and other exit costs. See discussion later in the management discussion and analysis. Impairment on Assets Held for Sale On August 10, 2001, the Board of Directors authorized the sale of substantially all of the manufacturing related assets of Seattle Orthopedic Group, Inc. (SOGI). After extensive review and analysis, the Company determined that the manufacture of orthotic and prosthetic components and devices was not a core business of Hanger representing only 1% of Hanger's revenue for the six months ended June 30, 2001 and 2% for the year ended December 31, 2000. The Company believes that its assets and management expertise can be more effectively deployed in its core business providing our orthotic and prosthetic patients with clinical excellence and superior customer service. The provision of treatment and service to orthotic and prosthetic patients represented 92.5% of Hanger's revenues for the six months ended June 30, 2001 and 92.1% of revenues for the year ended December 31, 2000. The sale of SOGI's manufacturing assets is expected to be completed by August 31, 2001 and such assets as of June 30, 2001 have a net carrying value of $19.37 million. The Company recorded an impairment loss of $8.176 million on the planned disposal of SOGI's manufacturing assets which has been reflected in the Company's statement of operations. Amendment No. 2 to the Amended and Restated Credit Agreement provides the Company with the ability to retain up to $5 million or the proceeds from the sale of SOGI for working capital purposes. These proceeds will only be retained by the Company for a specified period of time. The proceeds will then be applied to the term loans in accordance with the Credit Agreement. Income from Operations Principally as a result of the above, income from operations in the six months ended June 30, 2001 was approximately $10.5 million, a decrease of $18.2 million, or 63.3%, below the prior year's 20 comparable period. Income from operations as a percentage of net sales decreased to 4.2% during the first six months of 2001 from 11.9% for the prior year's comparable period. Interest Expense, Net Net interest expense in the six months ended June 30, 2001 was approximately $23.3 million, an increase of approximately $1.2 million over the approximately $22.1 million incurred in the six months ended June 30, 2001. Interest expense as a percentage of net sales increased to 9.3% for the six-month period ended June 30, 2001 compared to 9.2% for the prior year's comparable period. The increase in interest expense was primarily attributable to a $1.1 million increase in average borrowings during the six month period ended June 30, 2001 compared to the same period of the prior year and a 50 basis point increase in the LIBOR Adder as a result of the March 16, 2001 Amendment to the Credit Agreement which was partially offset by a reduction in LIBOR. Income Taxes The Company's effective tax rate was (63.5%) in the six months ended June 30, 2001 versus 67.6% in 2000. The Company's calculation of its effective tax rate is based on its projected annual earnings as adjusted for routine non-deductible items. The sale of SOGI represents a discrete event and a separate tax benefit was calculated for this event with an effective rate of 42%. Continuing operations were taxed based upon the Company's effective rate of (103%) as calculated using projected income amounts for the fiscal year. The decrease in the effective tax rate in the six months ended June 30, 2001 versus 2000 is the result of the decrease in projected annual earnings in relation to nondeductible items, primarily attributable to the July 1, 1999 acquisition of NovaCare O&P. The benefit for income taxes in the six months ended June 30, 2001 was approximately $8.0 million compared to the provision of $4.4 million for the same period in the prior year. Net Income (Loss) As a result of the above, the Company recorded net a net loss of $4.6 million, or $.37 loss per dilutive common share, in the six months ended June 30, 2001, compared to a net income of $2.1 million, or $.01 loss per dilutive common share, in the six months ended June 30, 2000. Liquidity and Capital Resources Cash flow provided by operating activities during the first six months of 2001 approximated $12.7 million, an increase of $19.0 million from the same period during 2000 level of cash flow provided by operating activities of $(6.3) million. The increase resulted from improvements in working capital during the first six months of 2001. Cash earnings, defined as Adjusted EBITDA less interest expense, restructuring and integration costs and current income tax expense, decreased approximately $12.8 million from $20.7 million in 2000 to $7.9 million in 2001. The Company's consolidated liquidity position (comprised of cash and cash equivalents and unused credit facilities) approximated $21.4 million at June 30, 2001 compared to approximately 21 $36.0 million at December 31, 2000. Consolidated working capital at June 30 2001 was approximately $149.9 million compared to the December 31, 2000 level of $133.7 million. The Company's total long term debt at June 30, 2001, including a current portion of approximately $32.9 million, was approximately $444.2 million. Such indebtedness included: (i) $150.0 million of 11.25% million Senior Subordinated Notes due 2009; (ii) $88.7 million for the Revolving Credit Facility; (iii) $80.0 million for Tranche A Term Facility; (iv) $98.5 million for Tranche B Term Facility; and (v) a total of $27.0 million of other indebtedness. The Revolving Credit Facility, and the Tranche A and B Term Facilities (the "Credit Facility") were entered into with The Chase Manhattan Bank, Bankers Trust Company, Paribas and certain other banks (the "Banks") in connection with the Company's acquisition of NovaCare O&P, Inc. on July 1, 1999. The Revolving Credit Facility matures on July 1, 2005; the Tranche A Term Facility is payable in quarterly installments of $5.0 million through July 1, 2005; and the Tranche B Term Facility is payable in quarterly installments of $250.0 through December 31, 2004 and in quarterly installments of $15.8 million, thereafter, through January 1, 2007. The Credit Facility contains certain affirmative and negative covenants customary in an agreement of this nature. At December 31, 2000, the Company was not in compliance with the financial covenants under the Credit Agreement for interest coverage and leverage coverage. In consideration for the bank's waiver of the Company's non-compliance with these covenants, an amendment to the amended and restated Credit Agreement dated as of March 16, 2001 was entered into which provides for an increase in the interest rates of the Credit Facility borrowings by 50 basis points. As of June 30 2001, the Company was in compliance with all of its financial covenants. Matters critical to the Company's compliance with the Credit Facility's covenants, and ultimately its immediate term liquidity (to the extent alternative sources of liquidity are not readily available), include improving operating results, through revenue growth and cost control, and reducing the Company's investment in working capital. As previously discussed, the Company has retained the services of Jay Alix & Associates to assist in identifying programs aimed at achieving these objectives. The Company's ability to continue to comply with the Credit Facility covenants is dependent on certain factors, including (a) the ability of the Company to effect the restructuring initiatives referred to above, and (b) the Company's ability to continue to attract and retain experienced management and O&P practitioners. Unexpected increases in the LIBOR rate could also adversely impact the Company's ability to comply with the Credit Facility's covenants. Management believes that the Company will continue to comply with the terms of the Credit Facility and that the Company's consolidated liquidity position is adequate to meet its short term and long term obligations. The Credit Facility is collateralized by substantially all of the Company's assets, restricts the payment of dividends and restricts the Company from pursuing acquisition opportunities for the calendar year 2001. All or any portion of outstanding loans under the Credit Facility may be repaid at any time and commitments may be terminated in whole or in part at our option without premium or penalty, except that LIBOR-based loans may only be repaid at the end of the applicable interest period. 22 Mandatory prepayments will be required in the event of certain sales of assets, debt or equity financings and under certain other circumstances. On June 22, 2001, Amendment No. 2 to the Amended and Restated Credit Agreement was entered into which provides the Company the ability to retain a certain portion of the proceeds from the divestiture of certain assets of the manufacturing division for working capital purposes. These proceeds will only be retained by the Company for a specified period of time. The proceeds will then be applied to the term loans in accordance with the Credit Agreement. The $60.0 million 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 the 7% Redeemable Preferred Stock be converted into non-voting common stock on and after July 2, 2002, if the average closing price of the common stock for 20 consecutive trading days is equal to or greater than 175% of the conversion price. The 7% Redeemable Preferred Stock will be mandatorily redeemable on July 1, 2010 at a redemption price equal to the liquidation preference plus all accrued and unpaid dividends. In the event of a change in control, the Company must offer to redeem all of the outstanding 7% Redeemable Preferred Stock at a redemption price equal to 101% of the sum of the per share liquidation preference thereof plus all accrued and unpaid dividends through the date of payment. The 7% Redeemable Preferred Stock accrues annual dividends, compounded quarterly, equal to 7%, and will not require principal payments prior to maturity on July 1, 2010. Agreement with Jay Alix & Associates On December 11, 2000, the Company retained the services of JA&A to assist in identifying areas for cash generation and profit improvement. Subsequent to the completion of this diagnostic phase, the Company modified and extended the retention agreement on January 23, 2001 to include the implementation of certain restructuring activities. Among the targeted plans are spending reductions, improving the utilization and effectiveness of support services, including claims processing, the refinement of materials purchasing and inventory management and the consolidation of distribution services. In addition, the Company will seek to enhance revenues through revised marketing efforts and more efficient billing procedures. The terms of this engagement provide for payment of JA&A's normal hourly fees plus a success fee if certain defined benefits are achieved. Management has elected to pay one-half of any earned success fees in cash, with the remaining one-half of the success fee paid through a grant of options to purchase the Company's stock. All the options will be granted with an exercise price of $1.40 per share, which was the average closing price of the Company's common stock for all trading days during the period from December 23, 2000 - January 23, 2001. The number of options will be determined by multiplying the non-cash half of each success fee invoice of JA&A by 1.5 and dividing the product by $1.40. The options are to be granted within 30 days of each invoice, shall be exercisable beginning with the sixth month following each award and shall expire five years from the termination of JA&A's engagement. The number of options that will be granted cannot be determined at this time. 23 Integration, Restructuring, and Asset Impairment Costs In December of 2000, management and the Board of Directors determined that major performance improvement initiatives needed to be adopted. Two hundred and thirty-four (234) employees were severed, resulting in a charge of approximately $1.0 million (the amount is offset by approximately $381,000 restructuring benefit described below), and in December 2000 the Company retained JA&A to do an assessment of the opportunities available for improved financial and operating performance. JA&A was retained to develop a comprehensive performance improvement program. The plan developed by JA&A and the Company calls for a $30.0 million reduction in operating expenses over a two year period, significant increase in patient revenue and reductions in inventory and accounts receivable levels. The plan calls for the incurrence of one-time, non-recurring costs of nearly $9.0 million during 2001. The performance improvement plan was provided to the secured lenders on February 23, 2001 and calls for formal quarterly status reports to the Hanger Board and lenders. As of December 31, 2000, the Company recorded approximately $693,000 in restructuring liabilities. Those amounts were paid in January of 2001. As noted above, the performance improvement plan developed by JA&A and the Company calls for a $30.0 million reduction in operating expenses and significant improvements in working capital and other areas. In connection with the implementation of the JA&A initiatives, the Company developed its performance improvement (restructuring - 2001) plan. The 2001 restructuring plan calls for the closure of 37 facilities and the termination of the employment of approximately 135 additional employees. As of June 30, 2001, 30 employees had been terminated, thirty-two of the facilities have been vacated and management recognized a restructuring benefit from its previous plan of $771. During the second quarter of 2001 management recorded approximately $3,688 in reserves for restructuring costs. The above restructuring charges and the related cost savings represent our best estimate, but necessarily make numerous assumptions with respect to industry performance, general business and economic conditions, raw materials and product pricing levels, government legislation, the timing of implementation of the restructuring and related employee reductions and patient-care center closings and other matters, many of which are outside of our control. Our estimate of cost savings is not necessarily indicative of future performance, which may be significantly more or less favorable than as set forth and is subject to the considerations relating to forward-looking statements that are set forth below under the caption "Forward Looking Statements". Class Action On November 28, 2000, a class action complaint (Norman Ottmann v. Hanger Orthopedic Group, Inc., Ivan R. Sabel and Richard A. Stein; Civil Action No. 00CV3508) was filed against the Company in the United States District Court for the District of Maryland on behalf of all purchasers of our common stock from November 8, 1999 through and including January 6, 2000. The complaint also names as defendants Ivan R. Sabel, Chairman of the Board, President and Chief Executive Officer of the Company, and Richard A. Stein, former Chief Financial Officer, Secretary and Treasurer of the Company. 24 The complaint alleges that during the above period of time, the defendants violated Section 10(b) and 20(a) of the Securities Exchange Act of 1934 by, among other things, knowingly or recklessly making material misrepresentations concerning the Company's financial results for the quarter ended September 30, 1999, and the progress of the Company's efforts to integrate the recently-acquired operations of NovaCare O&P. The complaint further alleges that by making those material misrepresentations, the defendants artificially inflated the price of the Company's common stock. The plaintiff seeks to recover damages on behalf of all of the class members. The Company believes that the allegations are without merit and plans to vigorously defend the lawsuit. New Accounting Standards In June 1998, the Financial Accounting Standard Board issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," which is effective for fiscal years beginning after June 15, 2000. SFAS 133 requires that an entity recognize all derivative instruments as either assets or liabilities on its balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction, and, if it is, the type of hedge transaction. The Company has adopted SFAS 133 as of January 1, 2001. As of June 30, 2001, the Company did not have any derivative instruments within the scope of SFAS 133. As such, the adoption does not have a material effect on the financial position or results of operation of the Company for the period ending June 30, 2001. On June 29, 2001, the FASB unanimously approved its proposed Statements of Financial Accounting Standards No. 141 (SFAS 141), Business Combinations, and No. 142 (SFAS 142), Goodwill and Other Intangible Assets. SFAS 141 supercedes Accounting Principles Board (APB) Opinion No. 16, Business Combinations. The most significant changes made by SFAS 141 are: (1) requiring that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, (2) establishing specific criteria for the recognition of intangible assets separately from goodwill, and (3) requiring unallocated negative goodwill to be written off immediately as an extraordinary gain rather than being deferred and amortized). The Company does not expect a material impact from the adoption of SFAS 141 on our consolidated financial statements. SFAS 142 supercedes APB 17, Intangible Assets. SFAS 142 primarily addresses accounting for goodwill and intangible assets subsequent to their acquisition (i.e., the post-acquisition accounting). The provisions of SFAS 142 will be effective for fiscal years beginning after December 15, 2001. However, early adoption of SFAS 142 will be permitted for companies with a fiscal year beginning after March 15, 2001, provided their first quarter financial statements have not been previously issued. In all cases, SFAS 142 must be adopted at the beginning of a fiscal year. The most significant changes made by SFAS 142 are: (1) goodwill and indefinite lived intangible assets will no longer be amortized, (2) goodwill will be tested for impairment at least annually at the reporting unit 25 level, (3) intangible assets deemed to have an indefinite life will be tested for impairment at least annually, and (4) the amortization period of intangible assets with finite lives will no longer be limited to forty years. The Company intends to adopt SFAS 142 effective January 1, 2002 and is currently evaluating the impact on our consolidated financial statements. 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. 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. 26 Item 3. 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 June 30, 2001, there were no interest rate swaps outstanding. 27 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K Exhibits and Reports on Form 8-K (a) Exhibits. The following exhibits are filed herewith: None (b) Forms 8-K. None 28 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HANGER ORTHOPEDIC GROUP, INC. Date: August 10, 2001 IVAN R. SABEL -------------------------------------------- Ivan R. Sabel Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer) Date: August 10, 2001 DENNIS T. CURRIER -------------------------------------------- Dennis T. Currier Chief Financial Officer (Principal Financial Officer) 29 -----END PRIVACY-ENHANCED MESSAGE-----