-----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, Jyme4q/czTTpr+uiCDnOdFg7VsEJWUtoGI/1FX0Sz8EMyutGqWLeSGxKis5EnPoz YI9GJmlPRIBBM0HXm0T6FQ== 0000897069-02-000383.txt : 20020515 0000897069-02-000383.hdr.sgml : 20020515 20020515145004 ACCESSION NUMBER: 0000897069-02-000383 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20020331 FILED AS OF DATE: 20020515 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: 02651222 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: SEQUEL CORP DATE OF NAME CHANGE: 19890814 FORMER COMPANY: FORMER CONFORMED NAME: CELLTECH COMMUNICATIONS INC DATE OF NAME CHANGE: 19860304 10-Q 1 slp292.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 March 31, 2002 ---------------------------------------- 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 May 10, 2002; 19,308,371 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 - March 31, 2002 (unaudited) and December 31, 2001 1 Consolidated Statements of Operations for the three months ended March 31, 2002 and 2001 (unaudited) 3 Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2001 (unaudited) 4 Notes to Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Item 3. Quantitative and Qualitative Disclosures About Market Risk 26 Part II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 27 SIGNATURES 28 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except share and per share amounts)
March 31, December 31, 2002 2001 ------------- ------------ (unaudited) ASSETS CURRENT ASSETS Cash and cash equivalents $ 6,902 $ 10,043 Accounts receivable, less allowances for doubtful accounts of $16,256 and $17,625 in 2002 and 2001, respectively 104,377 104,040 Inventories 54,314 55,946 Prepaid, other assets, and income taxes receivable 6,448 4,901 Deferred income taxes 20,957 20,957 -------- -------- Total current assets 192,998 195,887 -------- -------- PROPERTY, PLANT AND EQUIPMENT Land 3,739 4,078 Buildings 6,659 8,629 Machinery and equipment 29,532 28,675 Furniture and fixtures 10,043 9,967 Leasehold improvements 18,550 18,027 -------- -------- 68,523 69,376 Less accumulated depreciation and amortization 33,559 31,598 -------- -------- 34,964 37,778 -------- -------- INTANGIBLE ASSETS Excess cost over net assets acquired, less accumulated amortization of $38,915 and $36,727 in 2002 and 2001, respectively 447,428 440,874 Assembled workforce, less accumulated amortization of $0 and $2,188 in 2002 and 2001, respectively -- 4,812 Patents and other intangible assets, $10,124 less accumulated amortization of $3,677 and $3,430 in 2002 and 2001, respectively 6,447 6,694 -------- -------- 453,875 452,380 -------- -------- OTHER ASSETS Debt issuance costs, net 14,183 10,846 Other assets 3,196 3,016 -------- -------- Total other assets 17,379 13,862 -------- -------- TOTAL ASSETS $699,216 $699,907 ======== ========
The accompanying notes are an integral part of the consolidated financial statements. 1 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except share and per share amounts)
March 31, December 31, 2002 2001 --------------- -------------- (unaudited) LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Current portion of long-term debt $ 10,081 $ 30,512 Accounts payable 12,452 16,901 Accrued expenses 7,035 8,196 Accrued interest payable 7,796 2,017 Accrued compensation related cost 17,716 29,045 --------- --------- Total current liabilities 55,080 86,671 Long-term debt, less current portion 394,679 367,315 Deferred income taxes 26,495 26,495 Other liabilities 4,298 3,013 --------- --------- Total liabilities 480,552 483,494 --------- --------- 7% Redeemable Convertible Preferred stock, liquidation preference $1,000 per share 72,005 70,739 --------- --------- Commitments and contingent liabilities (See Note I) SHAREHOLDERS' EQUITY Common stock, $.01 par value; 60,000,000 shares authorized, 19,211,063 and 19,057,876 shares issued and outstanding in 2002 and 2001, respectively 192 191 Additional paid-in capital 147,402 146,674 Accumulated deficit (279) (535) --------- --------- 147,315 146,330 Treasury stock, cost -- (133,495 shares) (656) (656) --------- --------- 146,659 145,674 --------- --------- TOTAL LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY $ 699,216 $ 699,907 ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 2 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS For the Three Months Ended March 31, (Dollars in thousands, except share and per share amounts)
2002 2001 ------------ ------------ (unaudited) Net sales $ 123,510 $ 120,573 Cost of goods sold 59,537 62,974 ------------ ------------ Gross profit 63,973 57,599 Selling, general and administrative 44,777 42,689 Depreciation and amortization 2,784 3,058 Amortization of excess cost over net assets acquired -- 3,046 Unusual charges -- 1,515 ------------ ------------ Income from operations 16,412 7,291 Interest expense, net 9,079 12,258 ------------ ------------ Income (loss) before taxes 7,333 (4,967) Provision (benefit) for income taxes 3,000 (5,099) ------------ ------------ Income before extraordinary item 4,333 132 Extraordinary loss on early extinguishment of debt, net of tax benefit 2,811 -- ------------ ------------ Net income $ 1,522 $ 132 ============ ============ Income before extraordinary item applicable to common stock $ 3,067 $ (1,052) ============ ============ Net income (loss) applicable to common stock $ 256 $ (1,052) ============ ============ Basic Per Common Share Data Income (loss) before extraordinary item $ 0.16 $ (0.06) Extraordinary item, net of tax benefit (0.15) -- ------------ ------------ Net income (loss) $ 0.01 $ (0.06) ============ ============ Shares used to compute basic per common share amounts 19,137,586 18,910,002 ============ ============ Diluted Per Common Share Data Income (loss) before extraordinary item $ 0.14 $ (0.06) Extraordinary item, net of tax benefit (0.13) -- ------------ ------------ Net income (loss) $ 0.01 $ (0.06) ============ ============ Shares used to compute diluted per common share amounts 21,642,231 18,910,002 ============ ============
The accompanying notes are an integral part of the consolidated financial statements. 3 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the Three Months Ended March 31, (Dollars in thousands)
2002 2001 ------------- -------------- (unaudited) Cash flows from operating activities: Net income $ 1,522 $ 132 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Extraordinary loss on extinguishment of debt 2,811 -- Loss on disposal of assets 413 -- Provision for bad debts 5,158 5,123 Depreciation and amortization 2,784 3,058 Amortization of excess cost over net assets acquired -- 3,047 Amortization of debt issuance costs 513 607 Deferred income taxes (benefit) -- (678) Changes in assets and liabilities Accounts receivable (5,495) (2,434) Inventories 1,632 4,038 Prepaid, other assets, and income taxes receivable 272 (1,288) Other assets (181) (27) Accounts payable (4,964) (4,627) Accrued expenses and interest 4,618 (4,471) Accrued compensation related costs (11,329) 3,476 Other liabilities (765) (350) --------- --------- Net cash provided by (used in) operating activities (3,011) 5,606 --------- --------- Cash flows from investing activities: Purchase of fixed assets (1,626) (1,645) Acquisitions, net of cash acquired, and earnouts (1,226) (835) Proceeds from sale of fixed assets 1,492 79 --------- --------- Net cash used in investing activities (1,360) (2,401) --------- --------- Cash flows from financing activities: Net repayments under revolving credit agreement (34,300) -- Proceeds from sale of Senior Notes 200,000 -- Repayment and termination of bank loans (153,587) (8,000) Scheduled repayment of long-term debt (3,132) (4,477) Increase in financing costs (8,480) (1,059) Proceeds from issuance of Common Stock 729 -- --------- --------- Net cash provided by (used in) financing activities 1,230 (13,536) --------- --------- Decrease in cash and cash equivalents (3,141) (10,331) Cash and cash equivalents at beginning of period 10,043 20,669 --------- --------- Cash and cash equivalents at end of period $ 6,902 $ 10,338 ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 4 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - BASIS OF PRESENTATION The accompanying unaudited financial statements have been prepared in accordance with Rule 10-01 of Regulation S-X. They do not include all of the information and notes required by generally accepted accounting principles ("GAAP") for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of the financial statements have been included. Certain reclassifications of the prior year's data have been made to improve comparability. These financial statements should be read in conjunction with the financial statements of Hanger Orthopedic Group, Inc. (the "Company") and notes thereto included in the Annual Report of Form 10-K for the year ended December 31, 2001, filed by the Company with the Securities and Exchange Commission. NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES Use of Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Inventories Inventories, which consist principally of purchased parts and work in process, are stated at the lower of cost or market using the first-in, first-out (FIFO) method. The Company calculates cost of goods sold in accordance with the gross profit method. The Company bases the estimates used in applying the gross profit method on the actual results of the most recently completed fiscal year and other factors affecting cost of goods sold during the current reporting periods. Estimated cost of goods sold during the period is adjusted when the annual physical inventory is taken. Change in Accounting for Goodwill and Certain Other Intangibles Effective July 1, 2001 the Company adopted certain provisions of SFAS No. 141, and effective January 1, 2002, the Company adopted the full provisions of SFAS No. 141 and SFAS No. 142. 5 NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES (CONTINUED) Change in Accounting for Goodwill and Certain Other Intangibles (Continued) SFAS No. 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting, and broadens the criteria for recording intangible assets apart from goodwill. The Company evaluated its goodwill and intangibles acquired prior to June 30, 2001 using the criteria of SFAS No. 141, which resulted in other intangibles with an unamortized balance of $4.8 million (comprised entirely of assembled workforce intangibles) being combined into goodwill at January 1, 2002. SFAS No. 142 requires that purchased goodwill and certain indefinite-lived intangibles no longer be amortized, but instead be tested for impairment at least annually. The Company evaluated its intangible assets, other than goodwill, and determined that all such assets have determinable lives. SFAS No. 142 prescribes a two-phase process for impairment testing of goodwill. The first phase, required to be completed by June 30, 2002, screens for impairment; while the second phase (if necessary), required to be completed by December 31, 2002, measures the impairment. The company has completed the transitional impairment test, which did not result in the impairment of recorded goodwill. In completing the analysis, the Company determined that it had two reporting units, which were the same as its reportable segments: (i) patient-care centers and (ii) distribution. As of March 31, 2002, the patient-care center segment had an unamortized balance of goodwill of $447.4 million. 6 NOTE B - SIGNIFICANT ACCOUNTING PRINCIPLES (CONTINUED) Change in Accounting for Goodwill and Certain Other Intangibles (Continued) In accordance with SFAS No. 142, the effect of this accounting change is reflected prospectively. Supplemental comparative disclosure as if the change had been retroactively applied to the prior year period is as follows (in thousands, except per share amounts): Three months ended March 31, 2002 2001 ---- ---- Net income: Reported net income $ 1,522 $ 132 Goodwill amortization, net of tax benefit (1) -- (952) --------- --------- Adjusted net income (loss) $ 1,522 $ (820) ========= ========= Basic income (loss) per share: Reported income (loss) per share $ 0.01 $ (0.06) Goodwill amortization, net of tax benefit (1) $ -- $ (0.05) --------- --------- Adjusted basic income (loss) per share $ 0.01 $ (0.11) ========= ========= Diluted income (loss) per share: Reported income (loss) per share $ 0.01 $ (0.06) Goodwill amortization, net of tax benefit (1) $ -- $ (0.05) --------- --------- Adjusted diluted income (loss) per share $ 0.01 $ (0.11) ========= ========= (1) For 2001, includes $(0.1) million, net of tax, or $(0.00) per share, related to amortization of other intangibles that are classified as goodwill effective January 1, 2002. For 2001, consists of $3.3 million in amortization, offset by the reduction in the tax benefit of $4.3 million based on the revised effective tax rate for 2001. Amortization expense related to definite-lived intangile assets was $0.2 million for the three months ended March 31, 2002. Estimated aggregate amortization expense for such assets for each of the five years ended December 31, 2006 is as follows (in thousands): 2002 $ 963 2003 $ 839 2004 $ 768 2005 $ 762 2006 $ 751 NOTE C - SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION The following are the supplemental disclosure requirements for the statements of cash flows: 2002 2001 ---- ---- (in thousands) Cash paid during the period for: Interest $ 11,286 $ 10,997 Income taxes $ 63 $ 207 Non-cash financing and investing activities: Preferred stock dividends declared and accretion $ 1,266 $ 1,184 7 NOTE D - ACQUISITIONS The Company has not acquired any companies during the three months ended March 31, 2001 or 2002. In connection with the acquisition of NovaCare Orthotics & Prosthetics, Inc. ("NovaCare O&P") in July 1999, the Company assumed responsibility for payments of earnouts and working capital provisions related to acquisitions made by NovaCare O&P prior to July 1, 1999. In connection with these agreements and the Company's acquisitions prior to 2001, the Company paid $1.2 million and $0.8 million in the three-month periods ended March 31, 2002, and 2001, respectively. The Company has accounted for these amounts as additional purchase price, resulting in an increase in goodwill. The Company estimates that it may pay an additional $3.5 million related to earnout provisions in future periods. NOTE E - UNUSUAL CHARGES Restructuring Costs The 1999 and 2000 plans 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. All contemplated employees have been terminated and all contemplated patient-care centers have been closed. Lease payments on closed patient-care centers are expected to be paid through 2003. In the second quarter of 2001, in connection with the implementation of the Jay Alix & Associates ("JA&A") initiatives, the Company recorded approximately $3.7 million in restructuring and asset impairment costs. This plan, as amended in December 2001, called for the closure of 44 facilities and the termination of approximately 135 employees. As of March 31, 2002, 37 properties had been vacated and 134 employees had been terminated. All payments under the plan for lease and severance costs are expected to be paid by December 31, 2004. 8 NOTE E - UNUSUAL CHARGES (CONTINUED) Restructuring Costs (Continued) Components of the restructuring reserves, spending during the periods, and remaining reserve balances are as follows:
Lease Employee Termination Total Severance and other Exit Restructuring Costs Costs Reserve ----- ----- ------- (in thousands) 1999 & 2000 Restructuring Reserve Balance at December 31, 2001 $ -- $ 329 $ 329 Spending -- (36) (36) ------- ------- ------- Balance at March 31, 2002 -- 293 293 ------- ------- ------- 2001 Restructuring Reserve Balance at December 31, 2001 50 1,886 1,936 Spending (12) (286) (298) ------- ------- ------- Balance at March 31, 2002 38 1,600 1,638 ------- ------- ------- 1999, 2000, and 2001 Restructuring Reserves Balance at March 31, 2002 $ 38 $ 1,893 $ 1,931 ======= ======= =======
Performance Improvement Costs Unusual charges for the three months ended March 31, 2001 amounted to $1.5 million in fees paid to JA&A in connection with the development of the Company's performance improvement plan. JA&A's work with the Company was substantially completed as of December 31, 2001. In the fourth quarter of 2001, we were invoiced for and accrued a success fee based upon identified savings and operational improvements. Our contract with JA&A calls for one additional success fee, which will be based on the realization of further savings from initiatives that were not fully implemented by December 31, 2001. As of March 31, 2002, these savings are not yet measurable, and therefore, we are unable to estimate the amount, if any, related to this second success fee. NOTE F - NET INCOME (LOSS) PER COMMON SHARE Basic per common share amounts are computed using the weighted average number of common shares outstanding during the period. Diluted per common share amounts are computed using the weighted average number of common shares outstanding during the period and dilutive potential common shares. Dilutive potential common shares consist of stock options, stock warrants, redeemable convertible preferred stock and convertible notes payable and are calculated using the treasury stock method. 9 NOTE F - NET INCOME (LOSS) PER COMMON SHARE (CONTINUED) Earnings per share are computed based on the following amounts:
Three months ended March 31, (in thousands, except share amounts) 2002 2001 ---- ---- Income before extraordinary item $ 4,333 $ 132 Less preferred stock dividends declared and accretion (1,266) (1,184) ------------ ------------ Income (loss) before extraordinary item available to common stockholders used to compute basic per common share amounts $ 3,067 $ (1,052) ============ ============ Net income $ 1,522 $ 132 Less preferred stock dividends declared and accretion (1,266) (1,184) ------------ ------------ Net income (loss) available to common stockholders used to compute basic per common share amounts $ 256 $ (1,052) ============ ============ Shares of common stock outstanding used to compute basic per common share amounts 19,137,586 18,910,002 Effect of dilutive options 2,361,525 -- Effect of dilutive warrants 143,120 -- ------------ ------------ Shares used to compute dilutive per common share amounts (1) 21,642,231 18,910,002 ============ ============ (1) Excludes the effect of the conversion of the 7% Redeemable Convertible Preferred Stock into Common Stock as it is considered anti-dilutive. For 2001, excludes the effect of all dilutive options and warrants as a result of the Company's net loss before extraordinary item available to common shareholders for the three months ended March 31, 2001.
NOTE G - INVENTORY Inventories at March 31, 2002 and December 31, 2001 consist of the following: March 31, December 31, (in thousands) 2002 2001 ---- ---- Raw materials $27,183 $27,224 Work in process 19,907 19,908 Finished goods 7,224 8,814 ------- ------- $54,314 $55,946 ======= ======= 10 NOTE H - LONG TERM DEBT Long-term debt consisted of the following at March 31, 2002 and December 31, 2001:
March 31, December 31, (in thousands) 2002 2001 ---- ---- Revolving Credit Facility $ 40,500 $ 74,800 10 3/8% Senior Notes due 2009 197,952 -- A Term Loan Commitment -- 63,995 B Term Loan Commitment -- 89,592 11 1/4% Senior Subordinated Notes due 2009 150,000 150,000 Subordinated seller notes, non-collateralized net of unamortized discount of $0.1 million with principal and interest payable in either monthly, quarterly or annual installments at effective interest rates ranging from 6% to 12.287%, maturing through December 2011 16,308 19,440 --------- --------- 404,760 397,827 Less current portion (10,081) (30,512) --------- --------- $ 394,679 $ 367,315 ========= =========
On February 15, 2002, the Company sold $200.0 million principal amount of its 10 3/8% Senior Notes due 2009 (the "Senior Notes"). The notes mature in February 15, 2009, are senior indebtedness and are guaranteed by all of Hanger's domestic subsidiaries. Interest is payable semiannually on February 15 and August 15. On the same day, the Company established a new $75.0 million senior secured revolving line of credit (the "Revolving Credit Facility"). The new Revolving Credit Facility carries an interest rate of LIBOR plus 3.50% and matures on February 15, 2007. Hanger used the $194.0 million net proceeds from the sale of the Senior Notes, along with approximately $36.5 million from the Revolving Credit Facility, to retire approximately $228.4 million of indebtedness, plus related fees and expenses, outstanding under Hanger's previously existing revolving credit and term loan facilities. As a result of retiring the previously existing indebtedness, the Company wrote off $4.6 million in unamortized debt issuance costs that had previously been included in other assets. The extraordinary item for the three-months ended March 31, 2002 consists of such costs, offset by a tax benefit of $1.8 million. 11 NOTE H - LONG TERM DEBT (CONTINUED) In March 2002, the Company entered into two fixed-to-floating interest rate swaps with an aggregate notional amount of $100.0 million. The Company entered into the swaps in connection with the sale of the above notes and in order to mitigate its interest rate risk. Under the interest rate swap agreement, the Company will receive amounts based on a fixed interest rate of 10 3/8% per annum. In return, the Company will pay amounts based on a variable interest rate based on the six-month LIBOR plus a spread between 492 and 497 basis points. The Company will receive and pay these amounts semiannually through the maturity date of February 15, 2009. The terms of these agreements are identical to the Senior Notes. The Company has designated its interest rate swaps as fair value hedges. The Company has adjusted the carrying amount of the Senior Notes and the swaps by $2.0 million, the fair value of the swaps as of March 31, 2002. The interest rate swaps are included in other long-term liabilities. NOTE I - COMMITMENTS AND CONTINGENT LIABILITIES Commitments In October 2001, the Company entered into a Supply Agreement with United States Manufacturing Company, LLC ("USMC"), under which it agreed to purchase certain products and components for use solely by Hanger's patient-care centers during a five-year period following the date of the agreement. Hanger is obligated to purchase from USMC at least $7.5 million of products and components during the first year following the date of the agreement, $8.5 million of products and components during the second year following the agreement, and $9.5 million of products and components during the third year following the date of the agreement, subject to certain adjustments. However, in the event purchases during each of the fourth and fifth years are less than approximately $8.7 million, the Company shall pay USMC an amount equal to $0.1 million multiplied by the number of $1.0 million units by which actual purchases during each of the fourth and fifth years are less than approximately $8.7 million. Contingencies The Company is subject to legal proceedings and claims which arise in the ordinary course of its business, including claims related to alleged contingent additional payments under business purchase agreements. 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. 12 NOTE I - COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED) Contingencies (Continued) On November 28, 2000, a class action complaint (Norman Ottmann v. Hanger Orthopedic Group, Inc., Ivan R. Sabel and Richard A. Stein; Civil Action No. 00CV3508) was filed against the Company in the United States District Court for the District of Maryland on behalf of all purchasers of our common stock from November 8, 1999 through and including January 6, 2000. The complaint also names as defendants Ivan R. Sabel, the Company's Chairman of the Board and Chief Executive Officer of the Company, and Richard A. Stein, the Company's former Chief Financial Officer, Secretary and Treasurer. 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 have no merit and is vigorously defending the lawsuit. NOTE J - SEGMENT AND RELATED INFORMATION The Company has identified two reportable segments in which it operates based on the products and services it provides. The Company evaluates segment performance and allocates resources based on the segments' EBITDA. EBITDA is defined as net income (loss) before extraordinary item, interest, taxes, depreciation and amortization, and unusual charges consisting of impairment loss on assets held for sale, and integration, impairment, restructuring, and performance improvement costs. 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 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. Our definition of EBITDA may not be comparable to the definition of EBITDA used by other companies. Other "EBITDA" not directly attributable to reportable segments is primarily related to corporate general and administrative expenses. The two reportable segments are: (i) patient-care centers and (ii) distribution. A third segment that was previously reportable, manufacturing, was sold on October 9, 2001. On June 1, 2001, in anticipation of the sale of the manufacturing segment, the Company transferred its central fabrication ("Sea-Fab") operations from the manufacturing segment to the patient-care centers segment. Accordingly, all prior periods have been recast to be consistent with 2001 reporting. The reportable segments are described further below: 13 NOTE J - SEGMENT AND RELATED INFORMATION (CONTINUED) Patient-care centers - This segment consists of the Company's owned and operated O&P patient-care centers, fabrication centers of O&P components and OPNET. The patient-care centers provide services to design and fit orthotic and prosthetic devices to patients. These centers also instruct patients in the use, care and maintenance of the devices. Fabrication centers are involved in the fabrication of O&P components for both the O&P industry and the Company's own patient-care practices. OPNET is a national managed care agent for O&P services and a patient referral clearing house. Distribution - This segment distributes O&P products and components to both the O&P industry and the Company's own patient-care practices. Manufacturing - This previously reportable segment consisted of the manufacture of finished patient-care products for both the O&P industry and the Company's own patient-care practices. 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 patient-care centers segment and were made at prices which approximate market values.
Patient-Care Other and Centers Distribution Manufacturing Eliminations Total ------- ------------ ------------- ------------ ----- (in thousands) Three Months Ended March 31, 2002 Net sales Customers $ 116,947 $ 6,563 $ -- $ -- $ 123,510 ========= ========= ========= ========= ========= Intersegment $ -- $ 12,399 $ -- $ (12,399) $ -- ========= ========= ========= ========= ========= EBITDA $ 22,603 $ 1,144 $ -- $ (4,551) $ 19,196 Depreciation and amortization 2,358 90 -- 336 2,784 Interest expense, net 12,475 -- -- (3,396) 9,079 Provision for income taxes -- -- -- 3,000 3,000 Extraordinary item -- -- -- 2,811 2,811 --------- --------- --------- --------- --------- Net income (loss) $ 7,770 $ 1,054 $ -- $ (7,302) $ 1,522 ========= ========= ========= ========= ========= Three Months Ended March 31, 2001 Net sales Customers $ 111,046 $ 7,947 $ 1,580 $ -- $ 120,573 ========= ========= ========= ========= ========= Intersegment $ -- $ 12,775 $ 1,090 $ (13,865) $ -- ========= ========= ========= ========= ========= EBITDA $ 18,407 $ 1,556 $ 232 $ (5,285) $ 14,910 Depreciation and amortization 5,277 109 416 302 6,104 Unusual charges -- -- -- 1,515 1,515 Interest expense, net 12,709 -- 17 (468) 12,258 Benefit for income taxes -- -- -- (5,099) (5,099) --------- --------- --------- --------- --------- Net income (loss) $ 421 $ 1,447 $ (201) $ (1,535) $ 132 ========= ========= ========= ========= =========
14 NOTE K - CONSOLIDATING FINANCIAL INFORMATION The Company's Senior Notes, Senior Subordinated Notes and Revolving Credit Facility are guaranteed fully, jointly and severally, and unconditionally by all of the Company's current and future domestic subsidiaries. The following is summarized condensed consolidating financial information, as of March 31, 2002 and December 31, 2001 and for the three-month periods ended March 31, 2002 and 2001, of the Company, segregating the parent company (Hanger Orthopedic Group) and its guarantor subsidiaries, as each of the Company's subsidiaries is wholly-owned. 15 NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger Orthopedic Group (Parent Guarantor Consolidating Consolidated Company) Subsidiaries Adjustments Totals -------- ------------ ----------- ------ BALANCE SHEET - March 31, 2002 (in thousands) ASSETS Cash and cash equivalents $ (1,160) $ 8,062 $ -- $ 6,902 Accounts receivable -- 104,377 -- 104,377 Inventories -- 54,314 -- 54,314 Prepaid expenses and other assets 14,028 4,621 (12,201) 6,448 Intercompany receivable 118,797 (118,797) -- -- Deferred income taxes 20,957 -- -- 20,957 --------- --------- --------- --------- Total current assets 152,622 52,577 (12,201) 192,998 Property, plant and equipment, net 4,547 30,417 -- 34,964 Intangible assets, net (156) 454,031 -- 453,875 Investment in subsidiaries 69,498 -- (69,498) -- Other assets 421,207 2,872 (406,700) 17,379 --------- --------- --------- --------- Total assets $ 647,718 $ 539,897 $(488,399) $ 699,216 ========= ========= ========= ========= LIABILITIES, REDEEMABLE PREFERRED STOCK, AND SHAREHOLDERS' EQUITY Current portion of long-term debt $ -- $ 10,081 $ -- $ 10,081 Accounts payable 231 12,221 -- 12,452 Accrued expenses 3,367 3,668 -- 7,035 Accrued interest payable 7,368 12,629 (12,201) 7,796 Accrued compensation related cost 1,093 16,623 -- 17,716 --------- --------- --------- --------- Total current liabilities 12,059 55,222 (12,201) 55,080 Long-term debt, less current portion 388,452 412,927 (406,700) 394,679 Deferred income taxes 26,495 -- -- 26,495 Other liabilities 2,048 2,250 -- 4,298 --------- --------- --------- --------- Total liabilities 429,054 470,399 (418,901) 480,552 --------- --------- --------- --------- Redeemable preferred stock 72,005 -- -- 72,005 --------- --------- --------- --------- Common stock 192 35 (35) 192 Additional paid-in capital 147,402 7,461 (7,461) 147,402 Retained earnings (279) 62,542 (62,542) (279) Treasury stock (656) (540) 540 (656) --------- --------- --------- --------- Total shareholders' equity 146,659 69,498 (69,498) 146,659 --------- --------- --------- --------- Total liabilities, redeemable preferred stock, and shareholders' equity $ 647,718 $ 539,897 $(488,399) $ 699,216 ========= ========= ========= =========
16 NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONSOLIDATED)
Hanger Orthopedic Group (Parent Guarantor Consolidating Consolidated Company) Subsidiaries Adjustments Totals -------- ------------ ----------- ------ BALANCE SHEET - December 31, 2001 (in thousands) ASSETS Cash and cash equivalents $ (212) $ 10,255 $ -- $ 10,043 Accounts receivable -- 104,040 -- 104,040 Inventories -- 55,946 -- 55,946 Prepaid expenses and other assets 591 4,310 -- 4,901 Intercompany receivable 126,124 (126,124) -- -- Deferred income taxes 20,957 -- -- 20,957 --------- --------- --------- --------- Total current assets 147,460 48,427 -- 195,887 Property, plant and equipment, net 4,767 33,011 -- 37,778 Intangible assets, net (156) 452,536 -- 452,380 Investment in subsidiaries 60,673 -- (60,673) -- Other assets 417,672 2,890 (406,700) 13,862 --------- --------- --------- --------- Total assets $ 630,416 $ 536,864 $(467,373) $ 699,907 ========= ========= ========= ========= LIABILITIES, REDEEMABLE PREFERRED STOCK, AND SHAREHOLDERS' EQUITY Current portion of long-term debt $ 19,199 $ 11,313 $ -- $ 30,512 Accounts payable 520 16,381 -- 16,901 Accrued expenses 4,586 3,610 -- 8,196 Accrued interest payable 1,577 440 -- 2,017 Accrued compensation related cost 2,438 26,607 -- 29,045 --------- --------- --------- --------- Total current liabilities 28,320 58,351 -- 86,671 Long-term debt, less current portion 359,188 414,827 (406,700) 367,315 Deferred income taxes 26,495 -- -- 26,495 Other liabilities -- 3,013 -- 3,013 --------- --------- --------- --------- Total liabilities 414,003 476,191 (406,700) 483,494 --------- --------- --------- --------- Redeemable preferred stock 70,739 -- -- 70,739 --------- --------- --------- --------- Common stock 191 35 (35) 191 Additional paid-in capital 146,674 7,461 (7,461) 146,674 Retained earnings (535) 53,717 (53,717) (535) Treasury stock (656) (540) 540 (656) --------- --------- --------- --------- Total shareholders' equity 145,674 60,673 (60,673) 145,674 --------- --------- --------- --------- Total liabilities, redeemable preferred stock, and shareholders' equity $ 630,416 $ 536,864 $(467,373) $ 699,907 ========= ========= ========= =========
17 NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger Orthopedic Group (Parent Guarantor Consolidating Consolidated Company) Subsidiaries Adjustments Totals -------- ------------ ----------- ------ STATEMENT OF OPERATIONS Three months ended March 31, 2002 Net sales $ -- $ 135,909 $ (12,399) $ 123,510 Cost of goods sold -- 71,931 (12,394) 59,537 --------- --------- --------- --------- Gross profit -- 63,978 (5) 63,973 Selling, general and administrative 4,553 40,229 (5) 44,777 Depreciation and amortization 335 2,449 -- 2,784 --------- --------- --------- --------- Income (loss) from operations (4,888) 21,300 -- 16,412 Interest income (expense), net 3,396 (12,475) -- (9,079) Equity in earnings of subsidiaries 8,825 -- (8,825) -- --------- --------- --------- --------- Income (loss) before taxes 7,333 8,825 (8,825) 7,333 Provision for income taxes 3,000 -- -- 3,000 --------- --------- --------- --------- Income (loss) before extraordinary item 4,333 8,825 (8,825) 4,333 Extraordinary item (2,811) -- -- (2,811) --------- --------- --------- --------- Net income (loss) $ 1,522 $ 8,825 $ (8,825) $ 1,522 ========= ========= ========= ========= STATEMENT OF CASH FLOWS Three months ended March 31, 2002 Cash flows provided by (used in) operating activities $ (3,631) $ 2,183 $ (8,825) $ (3,011) Cash flows provided by (used in) investing activities (8,941) (1,244) 8,825 (1,360) Cash flows provided by (used in) financing activities 4,362 (3,132) -- 1,230 --------- --------- --------- --------- Net decrease in cash and cash equivalents (948) (2,193) -- (3,141) Cash and cash equivalents, beginning of period (212) 10,255 -- 10,043 --------- --------- --------- --------- Cash and cash equivalents, end of period $ (1,160) $ 8,062 $ -- $ 6,902 ========= ========= ========= =========
18 NOTE K - CONSOLIDATING FINANCIAL INFORMATION (CONTINUED)
Hanger Orthopedic Group (Parent Guarantor Consolidating Consolidated Company) Subsidiaries Adjustments Totals -------- ------------ ----------- ------ STATEMENT OF OPERATIONS Three months ended March 31, 2001 Net sales $ -- $ 134,448 $ (13,875) $ 120,573 Cost of goods sold -- 76,849 (13,875) 62,974 --------- --------- --------- --------- Gross profit -- 57,599 -- 57,599 Selling, general and administrative 6,044 36,645 -- 42,689 Depreciation and amortization 304 2,754 -- 3,058 Amortization of excess cost over net assets acquired -- 3,046 -- 3,046 Unusual charges 756 759 -- 1,515 --------- --------- --------- --------- Income (loss) from operations (7,104) 14,395 -- 7,291 Interest income (expense), net 469 (12,727) -- (12,258) Earnings in equity of subsidiaries 1,668 -- (1,668) -- --------- --------- --------- --------- Income (loss) before taxes (4,967) 1,668 (1,668) (4,967) Benefit for income taxes (5,099) -- -- (5,099) --------- --------- --------- --------- Net income (loss) $ 132 $ 1,668 $ (1,668) $ 132 ========= ========= ========= ========= STATEMENT OF CASH FLOWS Three months ended March 31, 2001 Cash flows provided by (used in) operating activities 3,313 3,961 $ (1,668) $ 5,606 Cash flows provided by (used in) investing activities (2,987) (1,082) 1,668 (2,401) Cash flows used in financing activities (9,059) (4,477) -- (13,536) --------- --------- --------- --------- Net decrease in cash and cash equivalents (8,738) (1,598) -- (10,331) Cash and cash equivalents, beginning of period (10,829) 9,840 -- 20,669 --------- --------- --------- --------- Cash and cash equivalents, end of period $ 2,096 $ 8,242 $ -- $ 10,338 ========= ========= ========= =========
19 ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations The following table sets forth for the periods indicated certain items of the Company's Statements of Operations and their percentage of the Company's net sales: 2002 2001 ----- ---- Net sales 100.0 % 100.0 % Cost of goods sold 48.2 52.2 Gross profit 51.8 47.8 Selling, general and administrative 36.2 35.4 Depreciation and amortization 2.3 2.5 Amortization of excess cost over net assets acquired - 2.5 Unusual charges - 1.3 Income from operations 13.3 6.1 Interest expense, net 7.4 10.2 Income (loss) before taxes 5.9 (4.1) Provision (benefit) for income taxes 2.4 (4.2) Net income before extraordinary item 3.5 0.1 Extraordinary item 2.3 - Net income 1.2 0.1 Three Months Ended March 31, 2002 Compared to the Three Months Ended March 31, 2001 Net Sales. Net sales for the quarter ended March 31, 2002, were approximately $123.5 million, an increase of approximately $2.9 million, or 2.4%, over net sales of approximately $120.6 million for the quarter ended March 31, 2001. The sales growth was primarily the result of a 5.4% increase in same center sales in the Company's O&P patient-care practices offset by a $1.4 million, or 1.2%, decrease in outside sales of the distribution segment and a $1.6 million, or 1.3%, reduction in sales due to the sale of Seattle Orthopedic Group, Inc., the Company's manufacturing division, in the third quarter of 2001. Gross Profit. Gross profit in the quarter ended March 31, 2002 was approximately $64.0 million, an increase of approximately $6.4 million, or 11.1%, over $57.6 million for the quarter ended March 31, 2001. Gross profit as a percentage of net sales increased to 51.8% in the first quarter of 2002 over 47.8% in the first quarter of 2001. The improvement in gross profit, in both dollars and as a percentage of sales, was due to a reduction in labor and material costs in connection with the Company's performance improvement initiatives. Selling, General and Administrative. Selling, general and administrative expenses in the quarter ended March 31, 2002 increased by $2.1 million, or 4.9%, compared to the quarter ended March 31, 2001. Selling, general and administrative expenses as a percentage of net sales increased to 20 36.2% in the first quarter of 2002 compared to 35.4% for same period in 2001. The increase in selling, general and administrative expenses in both dollars and as a percentage of sales was primarily due to an increase in performance-based bonus program costs, offset by a decrease in salaries and related benefits. Depreciation and Amortization. Depreciation and amortization for the three months ended March 31, 2002 amounted to $2.8 million, a 54.4% decrease in such costs over the $6.1 million for the three months ended March 31, 2001. The decrease is due to the discontinuation of amortization related to goodwill and other indefinite-lived intangible assets commencing January 1, 2002 pursuant to Statement of Financial Accounting Standards No. 142. Unusual Charges. Unusual charges for the three months ended March 31, 2001 amounted to $1.5 million in fees paid to Jay Alix & Associates ("JA&A") in connection with the development of the Company's performance improvement plan. No such costs were incurred during the three months ended March 31, 2002. JA&A's work with the Company was substantially completed as of December 31, 2001. In the fourth quarter of 2001, we were invoiced for and accrued a success fee based upon identified savings and operational improvements. Our contract with JA&A calls for one additional success fee, which will be based on the realization of further savings from initiatives that were not fully implemented by December 31, 2001. As of March 31, 2002, these savings are not yet measurable, and therefore, we are unable to estimate the amount, if any, related to this second success fee. Income from Operations. Principally as a result of the above, income from operations for the quarter ended March 31, 2002 was $16.4 million, an increase of $9.1 million, or 125.1%, compared to the quarter ended March 31, 2001. Income from operations as a percentage of net sales increased by 7.2 percentage points to 13.3% of net sales in the first quarter of 2002 over 6.1% for the prior year's comparable period. Interest Expense, Net. Interest expense in the first quarter of 2002 was $9.1 million, a decrease of $3.2 million from the $12.3 million incurred in the first quarter of 2001. The decrease in interest expense in dollars was primarily attributable to a decrease in average borrowings and a reduction in LIBOR. Income Taxes. The provision for income taxes for the three months ended March 31, 2002 was $3.0 million compared to a benefit from income taxes of $5.1 million for the three months ended March 31, 2001. The change in the income tax provision was due to the Company's return to profitability. Net Income (Loss) before Extraordinary Item. As a result of the above, we recorded net income before extraordinary item of $4.3 million for the three months ended March 31, 2002, compared to $0.1 million in the comparable quarter in the prior year, an improvement of $4.2 million. 21 Extraordinary Item. The extraordinary item of $2.8 million ($4.6 million pre-tax) in the three months ended March 31, 2002, represents the write-off of debt issue costs as a result of extinguishing $228.4 million of bank debt. Net Income (Loss). As a result of the above, we recorded net income of $1.5 million for the three months ended March 31, 2002, compared to net income of $0.1 million in the comparable quarter in the prior year, an improvement of $1.4 million. Financial Condition, Liquidity And Capital Resources Our working capital at March 31, 2002 was $137.9 million compared to $109.2 million at December 31, 2001. Our cash and cash equivalents amounted to $6.9 million at March 31, 2002 and $10.0 million at December 31, 2001. The current ratio improved to 3.5 to 1 at March 31, 2002, compared to 2.3 to 1 at December 31, 2001. Availability under our Revolving Credit Facility increased to $34.5 million at March 31, 2002 compared to $25.2 million at December 31, 2001. Net cash used in operating activities for the three months ended March 31, 2002 was $3.0 million, compared to $5.6 million provided by operating activities in the three months ended March 31, 2001. The $8.6 million decrease was primarily due to the payment of bonuses accrued as of December 31, 2001, which were paid in the first quarter of 2002 in order to secure a tax deduction in 2001. The accrued bonus at December 31, 2000 was not paid until the second quarter of 2001. Net cash used in investing activities was $1.4 million for the three months ended March 31, 2002, and was $2.4 million for the same period in the prior year. The increase in sales and profits in 2001 caused a $0.4 million increase in earnouts, which was offset by the proceeds from the sale of the building which formerly housed the Company's distribution segment. Net cash provided by financing activities was $1.2 million for the three months ended March 31, 2002. During that period, the Company received $194.0 million in net proceeds from the sale of the Company's 10 3/8% Senior Notes due 2009 ("Senior Notes"). These proceeds were offset by: (i) principal payments on our long-term debt of $156.7 million, (ii) a net paydown of $34.3 million of our revolving line of credit, and (iii) payment of $8.5 million in financing costs related to the issuance of the Company's 10 3/8% Senior Notes and the establishment of a new $75.0 million senior secured revolving line of credit ("New Revolving Credit Facility"). On February 15, 2002, we issued $200.0 million aggregate principal amount of 10 3/8% Senior Notes in a private placement exempt from registration under the Securities Act of 1933, as amended. We also established, concurrent with the sale of the Senior Notes, the New Revolving Credit Facility. The proceeds from these transactions were used to retire the existing revolving line of credit, Tranche A & B term loans, and for fees related to the transaction. 22 The Senior Notes mature on February 15, 2009 and do not require any prepayments of principal prior to maturity. Interest on the Senior Notes accrues from February 15, 2002, and is payable semi-annually on February 15 and August 15 of each year, commencing August 15, 2002. Payment of principal and interest on the Senior Notes is guaranteed on a senior unsecured basis by all of our current and future domestic subsidiaries. The indenture limits our ability to, among other things, incur additional indebtedness, create liens, pay dividends on or redeem capital stock, make certain investments, make restricted payments, make certain dispositions of assets, engage in transactions with affiliates, engage in certain business activities and engage in mergers, consolidations and certain sales of assets. The New Revolving Credit Facility, which was provided by a syndicate of banks and other financial institutions, is a senior secured Revolving Credit Facility providing for loans of up to $75.0 million and will terminate on February 15, 2007. Borrowings under the New Revolving Credit Facility will bear interest, at our option, at an annual rate equal to LIBOR plus 3.50% or the Base Rate (as defined in the New Revolving Credit Facility) plus 2.50% in each case, subject to adjustments based on financial performance. Our obligations under the New Revolving Credit Facility are guaranteed by our subsidiaries and are secured by a first priority perfected security interest in our subsidiaries' shares, all of our assets and all of the assets of our subsidiaries. Borrowings under the New Revolving Credit Facility are prepayable at any time without premium or penalty. The New Revolving Credit Facility requires compliance with various financial covenants, including a minimum consolidated interest coverage ratio, minimum consolidated EBITDA, a maximum total leverage ratio, a maximum senior secured leverage ratio and a minimum fixed charge coverage ratio, as well as other covenants. The New Revolving Credit Facility contains customary events of default and is subject to various mandatory prepayments and commitment reductions. We believe that, based on current levels of operations and anticipated growth, cash generated from operations, together with other available sources of liquidity, including borrowings available under the New Revolving Credit Facility, will be sufficient for the foreseeable future to fund anticipated capital expenditures and make required payments of principal and interest on our debt, including payments due on the Senior Notes and obligations under the New Revolving Credit Facility. In addition, we continually evaluate potential acquisitions and expect to fund such acquisitions from our available sources of liquidity, as discussed above. Market Risk We are exposed to the market risk that is associated with changes in interest rates. To manage that risk, in March 2002, we entered into interest rate swaps to modify our exposure to interest rate movements and reduce borrowing costs. We entered into $100.0 million fixed-to-floating interest rate swaps, consisting of floating rate instruments benchmarked to LIBOR. We are exposed to potential losses in the event of nonperformance by the counterparties to the swap agreements. 23 Critical Accounting Estimates The Company's analysis and discussion of its financial condition and results of operations are based upon its consolidated financial statements that have been prepared in accordance with generally accepted accounting principles in the United States ("U.S. GAAP"). The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. U.S. GAAP provides the framework from which to make these estimates, assumptions and disclosures. The Company chooses accounting policies within U.S. GAAP that management believes are appropriate to accurately and fairly report the Company's operating results and financial position in a consistent manner. Management regularly assesses these policies in light of current and forecasted economic conditions. The Company's accounting principles are stated in Note B to the Consolidated Financial Statements as presented in the Company's Annual Report on Form 10-K for the year ended December 31, 2001. In connection with the adoption of SFAS No. 142; Goodwill and Other Intangible Assets, the Company believes the following accounting policy is critical to understanding the results of operations and affect the more significant judgments and estimates used in the preparation of the consolidated financial statements. o Intangible Assets: Excess cost over net assets acquired represents the excess of purchase price over the value assigned to net identifiable assets of purchased businesses. Other definite-lived intangible assets include non-compete agreements which 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. The remainder of the other definite-lived intangible assets, including patents, are recorded at cost and are amortized over their estimated useful lives of up to 16 years using the straight-line method. SFAS 142 requires that excess cost over net assets acquired and indefinite-lived intangibles be tested for impairment annually. In connection with the impairment assessment management reviews and assesses, future cash flows, the market value of the Company's stock price as well as other market valuation indicators. Further changes in these items could result in an impairment. Impairment would be recognized by a charge to operating results and a reduction in the carrying value of the asset. 24 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 us 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, our Chairman of the Board, President and Chief Executive Officer, and Richard A. Stein, our former Chief Financial Officer, Secretary and Treasurer. 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 have no merit and is vigorously defending the lawsuit. 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 publicly update these forward-looking statements, whether as a result of new information, future events or otherwise. 25 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk In the normal course of business, we are exposed to fluctuations in interest rates. We address this risk by using interest rate swaps from time to time. At December 31, 2001 there were no interest rate swaps outstanding. In March 2002, the Company entered into two fixed-to-floating interest rate swaps with an aggregate notional amount of $100 million, as discussed in Note H to Hanger's Consolidated Financial Statements. 26 PART II. OTHER INFORMATION ITEM 6. Exhibits and Reports on Form 8-K Exhibits and Reports on Form 8-K (a) Exhibits. The following exhibits are filed herewith: Exhibit No. Document 10(a) Non-Qualified Stock Option Agreement, dated as of December 12, 2001, between the registrant and Jay Alix & Associates, Inc. (b) Forms 8-K. Current Report on Form 8-K dated February 15, 2002, reporting the private placement of $200.0 million principal amount of 10 3/8% Senior Notes due 2009 and the establishment of a new $75.0 million revolving credit facility. 27 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HANGER ORTHOPEDIC GROUP, INC. Dated: May 15, 2002 /s/ Ivan R. Sabel ----------------------------------- Ivan R. Sabel, CPO Chairman and Chief Executive Officer (Principal Executive Officer) Dated: May 15, 2002 /s/ George E. McHenry ----------------------------------- George E. McHenry Chief Financial Officer (Principal Financial Officer) Dated: May 15, 2002 /s/ Glenn M. Lohrmann ----------------------------------- Glenn M. Lohrmann Controller (Chief Accounting Officer) 28 EX-10.(A) 3 slp292a.txt NON-QUALIFIED STOCK OPTION AGREEMENT HANGER ORTHOPEDIC GROUP, INC. Non-Qualified Stock Option Agreement ------------------------------------ THIS AGREEMENT is made as of December 12, 2001, by and between HANGER ORTHOPEDIC GROUP, INC., a Delaware corporation (the "Company"), and Jay Alix & Associates, Inc. (the "Optionee"). W I T N E S S E T H: ------------------- WHEREAS, the Company desires to grant to the Optionee a non-qualified stock option to purchase One Million Two Hundred Two Thousand Four Hundred Thirty-Six (1,202,436) shares of the Company's common stock, par value $.01 per share (the "Common Stock"), in consideration for services rendered to the Company by the Optionee pursuant to the terms of the letter agreement, dated January 23, 2001 (the "Letter Agreement"), between the Company and the Optionee. NOW, THEREFORE, the parties hereto, intending to be legally bound, do agree as follows: 1. Grant of Option. Subject to the terms and conditions of this Agreement, the Company hereby grants to Optionee the right and option to purchase from the Company all or part of an aggregate of One Million Two Hundred Two Thousand Four Hundred Thirty-Six (1,202,436) shares of Common Stock. This option is not intended to qualify as an incentive stock option within the meaning of Section 422A of the Internal Revenue Code of 1986, as amended. 2. Option Price and Time of Exercise. The per-share purchase price at which the shares subject to option hereunder may be purchased by Optionee pursuant to its exercise of this option shall be $1.40, which price equals the average closing price per share of the Common Stock on the New York Stock Exchange for all trading days during the period from December 23, 2000 through January 23, 2001, as required under the terms of the Letter Agreement. The Optionee's right to exercise this option shall not vest until June 18, 2002, from and after which time the Optionee may exercise this option in whole or in part at any time prior to the expiration of this option on May 31, 2007 (the "Option Period"). The right to exercise this option shall be cumulative to the extent not theretofore exercised. 3. Method of Exercise and Payment for Shares. This option shall be exercised by written notice from the Optionee and delivered to the Company at its principal office, specifying the number of shares to be acquired upon such exercise and delivering therewith by wire transfer of funds or a certified check in an amount equal to the exercise price of the option multiplied by the number of shares of Common Stock to be acquired upon such exercise of the option by the Optionee. 4. Non-transferability of Option; Restricted Securities. This option is not transferable by Optionee, except only after the written consent of the Company, which shall not be unreasonably withheld, in connection with a merger of the Optionee or the transfer by the Optionee of all or substantially all of its assets (including this option), in which event this option may be transferred by the Optionee to such successor after the issuance of the written consent of the Company. The shares of Common Stock acquired by Optionee upon any exercise of this option shall be "restricted securities" within the meaning of Rule 144(a)(3) under the Securities Act of 1933 and Optionee shall be required to comply with and satisfy all applicable laws in any resale transactions conducted by Optionee which involve any such shares of Common Stock so acquired by Optionee under this option. 5. Merger, Consolidation, Acceleration of Option Vesting. (a) Effect of Transaction. Upon the occurrence of any of the following events, if the notice required by Section 5(b) hereof shall have first been given, the option granted hereunder shall automatically terminate and be of no further force and effect whatsoever, without the necessity for any additional notice or other action by the Company: (i) the merger, consolidation or liquidation of the Company or the acquisition of its assets or stock pursuant to a nontaxable reorganization, unless the surviving or acquiring corporation, as the case may be, shall assume all outstanding options of the Company or substitute new options for them pursuant to Section 425(a) of the Code; (ii) the dissolution or liquidation of the Company; (iii) the appointment of a receiver for all or substantially all of the Company's assets or business; (iv) the appointment of a trustee for the Company after a petition has been filed for the Company's reorganization under applicable statutes; or (v) the sale, lease or exchange of all or substantially all of the Company's assets and business. (b) Notice of Such Occurrences. At least 30 days' prior written notice of any event described in Section 6(a) hereof, except the transactions described in subsections 5(a)(iii) and (iv) as to which no notice shall be required, shall be given by the Company to the Optionee. If the Optionee is so notified, it may exercise all or a portion of the entire unexercised portion of this option at any time before the occurrence of the event requiring the giving of notice, regardless of whether such event occurs prior to June 18, 2002. Such notice shall be deemed to have been given when delivered personally to the Optionee or when mailed to the Optionee by registered or certified mail, postage prepaid, at the Optionee's last address known to the Company. 6. Adjustments Upon Certain Events. If the Company shall at any time increase or decrease the number of its outstanding shares of Common Stock by means of the payment of a stock dividend, a stock split or subdivision of shares, a consolidation or combination of shares, or through a reclassification of the then outstanding shares of Common Stock, then the aggregate number of shares of Common Stock subject to this Option and the exercise price of this Option shall be adjusted proportionately. 7. Binding Effect, Entire Agreement. Subject to the limitations stated above, this Agreement shall be binding upon and inure to the benefit of the Optionee (and its successor as provided in Section 4 of this Agreement) and the Company. This Agreement constitutes the entire agreement between the parties and cannot be altered, modified, or changed in any way 2 unless made in writing and signed by the party against whom such alteration, modification, or change is asserted. This Agreement shall be governed by the laws of the State of Delaware. IN WITNESS WHEREOF, the Company has caused this Agreement to be signed by its President and attested by its Secretary, and the Optionee has affixed its signature hereto. HANGER ORTHOPEDIC GROUP, INC. By: /s/ George McHenry --------------------------------- George McHenry Executive Vice President & Chief Financial Officer ACCEPTED BY: JAY ALIX & ASSOCIATES, INC. By: /s/ Melvin R. Christiansen --------------------------------- Melvin R. Christiansen Treasurer 3 -----END PRIVACY-ENHANCED MESSAGE-----