-----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, QGpAiMLeHYZgNAGrN4pWC0x9lWZeiY8BrMlP5WEhVUqGXKDtbSaSeAvWN6fBrIoZ EWj0+11/dXKxZOEVvawMCA== 0000928385-98-001223.txt : 19980612 0000928385-98-001223.hdr.sgml : 19980612 ACCESSION NUMBER: 0000928385-98-001223 CONFORMED SUBMISSION TYPE: S-3 PUBLIC DOCUMENT COUNT: 4 FILED AS OF DATE: 19980611 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: HANGER ORTHOPEDIC GROUP INC CENTRAL INDEX KEY: 0000722723 STANDARD INDUSTRIAL CLASSIFICATION: ORTHOPEDIC, PROSTHETIC & SURGICAL APPLIANCES & SUPPLIES [3842] IRS NUMBER: 840904275 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-3 SEC ACT: SEC FILE NUMBER: 333-56629 FILM NUMBER: 98646716 BUSINESS ADDRESS: STREET 1: 7700 OLD GEORGETOWN RD 2ND FL CITY: BETHESDA STATE: MD ZIP: 20814 BUSINESS PHONE: 3019860701 MAIL ADDRESS: STREET 2: 7700 OLD GEORGETOWN RD 2ND FL 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 S-3 1 FORM S-3 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 11, 1998 SEC FILE NO. 333- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- FORM S-3 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 --------------- HANGER ORTHOPEDIC GROUP, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 84-0904275 (I.R.S. EMPLOYER IDENTIFICATION (STATE OR OTHER JURISDICTION OF NUMBER) INCORPORATION OR ORGANIZATION) 7700 OLD GEORGETOWN ROAD BETHESDA, MD 20814 (301) 986-0701 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) --------------- IVAN R. SABEL CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER HANGER ORTHOPEDIC GROUP, INC. 7700 OLD GEORGETOWN ROAD BETHESDA, MD 20814 (301) 986-0701 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) --------------- PLEASE SEND COPIES OF COMMUNICATIONS TO: ARTHUR H. BILL, ESQ. MICHAEL J. SILVER, ESQ. FREEDMAN, LEVY, KROLL & SIMONDS HOGAN & HARTSON L.L.P. 1050 CONNECTICUT AVE., N.W. 111 SOUTH CALVERT STREET WASHINGTON, D.C. 20036 BALTIMORE, MD 21202 --------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after this Registration Statement becomes effective. If the only securities being registered on this form are being offered pursuant to dividend or interest reinvestment plans, please check the following box. [_] If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [_] If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If delivery of the Prospectus is expected to be made pursuant to Rule 434, please check the following box. [_] ---------------
CALCULATION OF REGISTRATION FEE - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- PROPOSED MAXIMUM MAXIMUM OFFERING AGGREGATE AMOUNT OF TITLE OF SHARES TO BE AMOUNT TO BE PRICE OFFERING REGISTRATION REGISTERED REGISTERED PER SHARE(1) PRICE(1) FEE - ---------------------------------------------------------------------------------- Common Stock, par value $0.01 per share....... 3,795,000 shares(2) $19.9375 $75,662,812 $22,320.53 - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
(1) Estimated in accordance with Rule 457(c) under the Securities Act of 1933 solely for the purpose of determining the registration fee and based on the average of the high and low sale prices of the Common Stock on the American Stock Exchange on June 4, 1998. (2) Includes 495,000 shares issuable upon exercise of the Underwriters' over- allotment option. --------------- THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(A), MAY DETERMINE. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SUBJECT TO COMPLETION JUNE , 1998 3,300,000 Shares [LOGO OF HANGER ORTHOPEDIC GROUP INC.] Common Stock -------- Of the 3,300,000 shares of Common Stock, par value $0.01 per share (the "Common Stock"), offered hereby, 2,400,000 shares are being sold by Hanger Orthopedic Group, Inc. ("Hanger" or the "Company") and 900,000 shares are being sold by certain stockholders of the Company (the "Selling Stockholders"). The Company will not receive any of the proceeds from the sale of shares of Common Stock by the Selling Stockholders. The Common Stock is quoted on the American Stock Exchange ("AMEX") under the symbol "HGR." On June 9, 1998, the last reported sale price of the Common Stock was $20.13. -------- THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" BEGINNING ON PAGE 8. -------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PRICE UNDERWRITING PROCEEDS PROCEEDS TO TO DISCOUNTS AND TO SELLING PUBLIC COMMISSIONS COMPANY(1) STOCKHOLDERS - -------------------------------------------------------------------------------- Per Share......................... $ $ $ $ - -------------------------------------------------------------------------------- Total(2).......................... $ $ $ $ - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
(1) Before deducting expenses of the offering estimated at $650,000, payable by the Company. (2) The Company has granted the Underwriters a 30-day option to purchase up to 495,000 additional shares of Common Stock solely to cover over-allotments, if any. To the extent that the option is exercised, the Underwriters will offer the additional shares at the Price to Public shown above. If the option is exercised in full, the total Price to Public, Underwriting Discounts and Commissions, and Proceeds to Company will be $ , $ and $ , respectively. See "Underwriting." -------- The shares of Common Stock are offered by the several Underwriters, subject to prior sale, when, as and if delivered to and accepted by them, and subject to the right of the Underwriters to reject any order in whole or in part. It is expected that delivery of the shares of Common Stock will be made at the offices of BT Alex. Brown Incorporated, Baltimore, Maryland, on or about , 1998. BT ALEX. BROWN NATIONSBANC MONTGOMERY SECURITIES LLC LEGG MASON WOOD WALKER INCORPORATED THE DATE OF THIS PROSPECTUS IS , 1998. INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. [LOGO OF HANGER ORTHOPEDIC GROUP INC.] 240 PATIENT-CARE CENTERS 6 DISTRIBUTION FACILITIES 2 MANUFACTURING FACILITIES [MAP AND PHOTOS] The Company's executive offices are located at 7700 Old Georgetown Road, Bethesda, Maryland 20814. Its telephone number is (301) 986-0701. ---------------- THE UNDERWRITERS AND OTHER PERSONS MAY OVER-ALLOT OR EFFECT TRANSACTIONS THAT STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING." 3 PROSPECTUS SUMMARY The following summary is qualified in its entirety by the more detailed information and consolidated financial statements and notes thereto appearing elsewhere in this Prospectus. THE COMPANY Hanger Orthopedic Group, Inc. is a professional practice management company focused on the orthotic and prosthetic ("O&P") segment of the orthopedic rehabilitation industry. The Company acquires and operates the practices of orthotists and prosthetists, medical professionals who design, fabricate, fit and supervise the use of external musculoskeletal support devices and artificial limbs. The Company has acquired over 60 O&P businesses since 1986 and currently employs 280 certified O&P practitioners and owns and operates 240 O&P patient-care centers in 30 states and the District of Columbia. The Company has also developed OPNET, Inc. ("OPNET"), a national preferred provider network of O&P service professionals. OPNET has contractual relationships with 358 O&P patient-care centers (240 of which are owned and operated by the Company), serving 291 managed care plans. In addition to its practice management and patient-care services, the Company manufactures custom-made and prefabricated O&P devices and is the largest distributor of O&P components and finished O&P patient-care products in the United States. The combination of practice management and patient-care services, OPNET, distribution and manufacturing operations positions the Company as a fully-integrated provider of O&P services. The Company has been an active acquiror of O&P practices since 1986. In 1995, the Company launched its OPNET network and, on November 1, 1996, acquired J.E. Hanger, Inc. of Georgia ("JEH"), an O&P provider with 96 patient-care centers in 15 states and the largest O&P distribution business in the United States. The acquisition essentially doubled the Company's number of patient-care centers and certified practitioners and significantly expanded its distribution capabilities. Since January 1, 1998, the Company has acquired the assets of five additional O&P companies, representing an aggregate of 25 patient-care centers and 33 certified practitioners. The Company estimates that the O&P patient-care services industry in the United States represented approximately $2.3 billion in sales in 1997. Key trends expected to increase the demand for O&P services include: (i) the growing elderly population; (ii) more active lifestyles and emphasis on physical fitness; (iii) cost savings achieved through the use of outpatient O&P treatments to reduce hospitalization; (iv) advancing technologies in the design and manufacture of O&P devices; and (v) the inherent need for replacement of O&P devices and continuing care. The O&P services market is highly fragmented and relatively underpenetrated by professional practice management companies. Hanger is one of the two largest companies in the O&P industry which, combined, accounted for less than 15% of the total estimated O&P industry revenue in 1997. There are an estimated 3,300 certified prosthetists and/or orthotists and approximately 2,850 O&P patient- care centers in the United States. The Company believes that the O&P industry will continue to consolidate as a result of a variety of factors, including: (i) increased pressures from growth in managed care; (ii) demonstrated benefits from economies of scale; and (iii) desire by independent orthotists and prosthetists to obtain financial liquidity and concentrate on providing patient care. The Company's objective is to build a major national orthopedic rehabilitation company focused on the acquisition and operation of O&P practices and the manufacturing and distribution of O&P products. The Company's strategy for achieving this objective is to: (i) acquire and integrate O&P practices in targeted geographic areas across the United States; (ii) develop new O&P patient-care centers in existing markets; (iii) expand and improve O&P practice management operations at existing and acquired patient-care centers; (iv) increase OPNET's number of O&P patient-care service members and contractual relationships with managed care organizations; and (v) leverage and expand the Company's O&P manufacturing and distribution operations. 4 RISK FACTORS The Common Stock offered hereby involves a high degree of risk. See "Risk Factors." THE OFFERING Common Stock offered by the Company............... 2,400,000 shares Common Stock offered by the Selling Stockholders.. 900,000 shares Common Stock to be outstanding after the offering......................................... 18,140,631 shares(1) Use of proceeds................................... Repayment of certain indebtedness and general corporate purposes. See "Use of Proceeds." American Stock Exchange symbol.................... HGR
- -------- (1) Excludes 2,740,720 shares of Common Stock issuable upon exercise of outstanding stock options and warrants, at a weighted average exercise price of $6.53 per share. See "Capitalization" and "Principal and Selling Stockholders." Unless the context otherwise requires, references to the Company include Hanger Orthopedic Group, Inc. and its subsidiaries. Except as otherwise specified, all information in this Prospectus assumes no exercise of the Underwriters' over-allotment option. See "Underwriting." 5 SUMMARY CONSOLIDATED FINANCIAL AND STATISTICAL DATA (IN THOUSANDS, EXCEPT PER SHARE AND STATISTICAL DATA)
YEARS ENDED DECEMBER 31, QUARTERS ENDED MARCH 31, ----------------------------------------------------- --------------------------- PRO FORMA PRO FORMA AS ADJUSTED AS ADJUSTED 1993 1994 1995 1996 1997 1997(1) 1997 1998 1998(2) ------- ------- ------- ------- -------- ----------- ------- ------- ----------- STATEMENTS OF INCOME DATA: Net sales............... $43,877 $50,300 $52,468 $66,806 $145,598 $170,647 $30,950 $40,750 $43,052 Acquisition and integration costs, restructuring costs and loss on disposal of assets................. -- 2,610 -- 2,479 -- -- -- -- -- Income from continuing operations............. 4,428 4 5,843 4,695 18,308 22,213 2,636 3,458 3,591 Income (loss) before extraordinary item and accounting change...... 1,490 (2,687) 2,135 1,081 7,640 10,020 618 1,695 1,981 Net income (loss)....... $ 2,655 $(2,687) $ 2,135 $ 998 $ 4,946 $ 10,020 $ 618 $ 1,695 $ 1,981 Diluted net income (loss) per common share from continuing operations before extraordinary item and accounting change(3)... $ 0.19 $ (0.28) $ 0.25 $ 0.12 $ 0.58 $ 0.64 $ 0.06 $ 0.10 $ 0.10 Diluted net income (loss) per common share(3)............... $ 0.32 $ (0.33) $ 0.25 $ 0.11 $ 0.37 $ 0.64 $ 0.06 $ 0.10 $ 0.10 Shares used to compute diluted per common share amounts(3)....... 8,267 8,290 8,300 8,663 13,138 15,561 9,941 17,082 19,482
MARCH 31, 1998 --------------------------------------- PRO FORMA ACTUAL PRO FORMA(4) AS ADJUSTED(4)(5) -------- ------------ ----------------- BALANCE SHEET DATA: Working capital........................ $ 35,856 $ 34,846 $ 59,030 Total assets........................... 169,407 170,221 187,745 Long-term debt......................... 29,286 29,799 8,869 Shareholders' equity................... 108,927 108,927 154,041
QUARTERS ENDED YEARS ENDED DECEMBER 31, MARCH 31, ------------------------------ --------------- 1993 1994 1995 1996 1997 1997 1998 ----- ------ ----- ----- ----- ------- ------- STATISTICAL DATA: Facility operations: Patient-care centers(6)..... 72 85 84 178 213 178 238 Certified practitioners(6).. 104 125 119 199 248 197 278 Number of states (including D.C.)(6)................... 22 25 24 29 30 29 30 Same-center sales growth.... 4.4% (3.7)% 5.2% 5.8% 11.7% 10.6% 13.8% EBITDA margin(7)............. 16.1% 11.1% 16.1% 14.7% 15.6% 12.1% 11.7% Operating margin(8).......... 10.1% 5.2% 11.1% 10.7% 12.6% 8.5% 8.5% Payor mix(9): Private pay and other....... -- -- 43.4% 43.2% 38.0% 43.0% 48.0% Medicare/Medicaid/VA........ -- -- 56.6% 56.8% 62.0% 57.0% 52.0% Percent of net sales: Practice management and patient-care services...... 76.8% 78.0% 78.5% 78.2% 77.1% 74.6% 79.0% Manufacturing............... 18.3% 17.6% 16.3% 12.0% 5.3% 6.3% 4.2% Distribution................ 4.9% 4.4% 5.2% 9.8% 17.6% 19.1% 16.8%
See accompanying notes on the following page. 6 - -------- (1) Adjusted to give effect to: (i) acquisitions which occurred during 1997 and the five months ended May 31, 1998; and (ii) the reduction in interest expense resulting from the application of the estimated net proceeds of this offering upon the sale by the Company of 2,400,000 shares of Common Stock offered hereby at an assumed public offering price of $20.13, as if all such transactions had occurred on January 1, 1997. See "Use of Proceeds" and "Selected Unaudited Pro Forma Condensed Consolidated Financial Information." (2) Adjusted to give effect to: (i) acquisitions which occurred during the five months ended May 31, 1998; and (ii) the reduction in interest expense resulting from the application of the estimated net proceeds of this offering upon the sale by the Company of 2,400,000 shares of Common Stock offered hereby at an assumed public offering price of $20.13, as if all such transactions had occurred on January 1, 1998. See "Use of Proceeds" and "Selected Unaudited Pro Forma Condensed Consolidated Financial Information." (3) During the fourth quarter of 1997, the Company adopted the provisions of Statement of Financial Accounting Standard ("SFAS") 128 and, as required, has restated all prior period per common share data. Diluted net income 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 and stock warrants and are calculated using the treasury stock method. Diluted net income per common share amounts have been adjusted for preferred stock dividends. (4) Adjusted to give effect to acquisitions which occurred during the five months ended May 31, 1998. See "Selected Unaudited Pro Forma Condensed Consolidated Financial Information." (5) Adjusted to give effect to the sale by the Company of 2,400,000 shares of Common Stock offered hereby at an assumed public offering price of $20.13 and the application of the estimated net proceeds therefrom. See "Use of Proceeds." (6) Numbers of patient-care centers, certified practitioners and states are determined as of period end. (7) "EBITDA" is defined as net income (loss) before interest expense, taxes, depreciation and amortization, discontinued operations, non-recurring charges, extraordinary item and accounting change. EBITDA is not a measure of performance under GAAP. While EBITDA should not be considered in isolation or as a substitute for net income, cash flows from operating activities and other income or cash flow statement data prepared in accordance with GAAP, or as a measure of profitability or liquidity, management understands that EBITDA is customarily used as a criteria in evaluating health care companies. Moreover, substantially all of the Company's financing agreements contain covenants in which EBITDA is used as a measure of financial performance. EBITDA margin is defined as EBITDA as a percent of net sales. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for a discussion of measures of performance determined in accordance with GAAP. (8) Operating margin is defined as net income (loss) before interest expense, taxes, discontinued operations, non-recurring charges, extraordinary item and accounting change as a percent of net sales. (9) Payor mix data for the years ended December 31, 1996 and 1997 and for the quarters ended March 31, 1997 and 1998 is based on a sampling of approximately 75% of the patient-care centers in each such period. Payor mix data is not available for the years ended December 31, 1993 and 1994. 7 RISK FACTORS In addition to the other information in this Prospectus, the following factors should be considered carefully in evaluating an investment in shares of the Common Stock offered by this Prospectus. This discussion also identifies important cautionary factors that could cause the Company's actual results to differ materially from those described in forward-looking statements made in this Prospectus, including those regarding the acquisition of additional patient-care centers and related businesses, the adequacy of the Company's capital resources and other statements regarding trends. These forward-looking statements could be affected by a number of risks and uncertainties including those described below. RISKS ASSOCIATED WITH ACQUISITION STRATEGY The Company's business strategy contemplates the continued acquisition and integration of O&P businesses. The success of the Company's acquisitions will be determined by numerous factors, including the Company's ability to identify O&P patient-care practices and other O&P businesses suitable for acquisition, to acquire and finance such businesses on acceptable terms and to integrate and operate such businesses profitably after acquisition. No assurance can be given that future acquisitions by the Company will be successfully consummated and integrated or that such acquisitions will favorably affect the Company's business or operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" and "Business--Acquisitions." ADDITIONAL FINANCINGS The Company's acquisition program requires substantial capital resources. No assurance can be given that the Company's available bank facility and other sources of capital will be sufficient to provide for the Company's cash requirements for future acquisitions. The Company may issue additional debt or equity securities in connection with the acquisition of additional O&P patient-care centers. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" and "Business--Acquisitions." RAPID GROWTH The Company has pursued, and plans to continue to pursue, an aggressive growth strategy. The rapid growth may place significant demands on the Company's financial and managerial resources. There can be no assurance that the Company will be able to manage this growth effectively. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Liquidity and Capital Resources" and "Business." REIMBURSEMENT LIMITATIONS Approximately 62.0% and 52.0% of the Company's net sales in 1997 and the first quarter of 1998, respectively (based on a sampling of approximately 75% of the patient-care centers in both periods), were derived from Medicare, Medicaid, the United States Veterans Administration (the "VA") and certain state agencies, each of which sets maximum reimbursement levels for O&P services and products. No assurance can be given that reimbursement levels under such programs will not be lowered in the future or that the percentage of the Company's net sales derived from sources limiting reimbursement levels will not increase. Furthermore, the health care industry is experiencing a trend towards cost containment as government and other third-party payors seek to impose lower reimbursement rates and negotiate reduced contract rates with service providers, which may adversely affect the Company's financial condition or results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Other" and "Business-- Patient Reimbursement Sources." RETENTION OF KEY PERSONNEL The success of the Company will depend in part on its continued ability to retain Ivan R. Sabel, Chairman of the Board, President and Chief Executive Officer of the Company, qualified O&P practitioners and other managerial and technical personnel. There can be no assurance that the Company will be able to continue to retain all of the personnel necessary for continued growth. The loss of the services of key personnel could have a material adverse effect on the Company. See "Management." 8 VARIABILITY OF QUARTERLY OPERATING RESULTS The Company's operating results have varied from quarter to quarter and may continue to vary. Quarterly variations may result from, among other things, the non-recurring costs associated with the acquisition of O&P patient-care centers and seasonal factors. The Company's operating results for any particular quarter may not be indicative of results for future periods. POTENTIAL LIABILITY AND INSURANCE The provision of O&P services and products, as is the case with other health care services and products, involves an inherent risk of liability that could have a material adverse effect on the Company. No assurance can be given that insurance coverage will continue to be available at commercially reasonable prices or that such insurance will cover actual future liabilities. POTENTIAL ADVERSE CONSEQUENCES FROM CHANGE IN MANAGEMENT INFORMATION SYSTEMS The Company plans to upgrade its management information systems sometime during late 1998 and early 1999. The systems that will be upgraded include the systems utilized in the Company's corporate headquarters and patient-care centers for billing purposes. The Company believes that it may experience some disruptions, including possible increases in accounts receivable due to billing delays, in connection with the transition from the existing systems to the new systems. The Company expects to run parallel systems until management is confident that the new systems are fully functional. The Company has hired a Director of Information Systems to oversee the transition. GOVERNMENT REGULATION Most states do not require separate licensure for O&P practitioners. However, several states currently require practitioners to be certified by an organization such as the American Board for Certification in Orthotics and Prosthetics (the "ABC"). While the Company endeavors to comply with all state licensure requirements, no assurance can be given that the Company will be in compliance at all times with these requirements. The Company is subject to various federal and state laws pertaining to health care fraud and abuse, including antikickback laws, false claims laws and physician self-referral laws. Antikickback laws make it illegal to solicit, offer, receive, or pay any remuneration in exchange for, or to induce, the referral of business. False claims laws prohibit anyone from knowingly and willfully presenting claims for payment that contain false or fraudulent information. Physician self-referral laws restrict the ability of a physician to refer patients to entities with which the physician has a financial relationship, as well as the ability of an entity to claim reimbursement for services furnished pursuant to a prohibited referral. Violations of these laws are punishable by criminal and/or civil sanctions, including, in some instances, imprisonment and exclusion from participation in federal health care programs, including Medicare, Medicaid, VA health programs and the Civilian Health and Medical Program for the Uniformed Services ("CHAMPUS"). There can be no assurance that one or more of the Company's practices will not be challenged by governmental authorities under certain of these laws, that the Company would not be required to alter its practices as a result, or that the occurrence of one or more of these events would not result in a material adverse effect on the Company's financial condition and results of operations. The Company is subject to federal and state antitrust laws which prohibit, among other things, the establishment of ventures that result in certain anticompetitive conduct. These laws have been applied to the establishment of certain networks of otherwise competing health care providers. There can be no assurance that governmental authorities would not bring an investigation or proceeding challenging this or some other aspect of the Company's operations under these laws, or that such an investigation or proceeding would not result in a material adverse effect on the Company's financial condition and results of operations. See "Business--Government Regulation." COMPETITION The business of providing O&P patient-care services is highly competitive. In addition to many local O&P practices, there are several regional and multi- regional competitors which operate numerous patient-care centers. The competition among O&P patient-care centers is primarily for referrals from physicians, therapists, employers, health maintenance organizations ("HMOs"), preferred provider organizations ("PPOs"), hospitals, 9 rehabilitation centers, outpatient clinics and insurance companies on both a local and regional basis. Hanger also competes with other providers of O&P services such as hospitals, physicians and therapists. In connection with its efforts to acquire additional O&P patient-care practices, the Company encounters competition from several other companies. The Company also encounters competition from other manufacturers of non-customized O&P components. Finally, although the Company is the country's largest distributor of O&P products, a majority of which are manufactured by other companies, Hanger encounters competition from numerous smaller companies engaged in the distribution of O&P products. There can be no assurance that levels of competition will not increase or that such competition will not have a material adverse effect on the Company's O&P patient-care services, manufacturing or distribution activities or O&P patient-care practice acquisition program. See "Business--Competition." SHARES ELIGIBLE FOR FUTURE SALE As of May 31, 1998, the Company had 15,740,631 shares of Common Stock outstanding, of which 14,641,631 shares are freely tradeable without restriction under the federal securities laws, except for shares held by affiliates of the Company. Of the currently outstanding shares, 1,099,000 shares constitute "restricted securities" as that term is defined under Rule 144 under the Securities Act of 1933, with 1,042,295 shares being eligible for resale at this time, subject to compliance with volume limitations and other restrictions under Rule 144, and the balance of 56,705 shares to be eligible for resale under Rule 144 commencing December 31, 1998. In addition, the Company has an outstanding note which is convertible into Common Stock beginning on March 31, 1999. If the holder of this note exercises his right to convert one-fifth of the principal amount of the note annually, an additional 23,143 shares would be eligible for resale on each of March 31, 1999, 2000, 2001, 2002 and 2003. As of May 31, 1998, there were a total of 1,550,071 shares of Common Stock underlying outstanding options (of which options for 371,647 shares are presently exercisable) and 1,190,649 shares underlying currently exercisable warrants to purchase shares from the Company. The shares underlying substantially all of the outstanding options will be freely tradeable upon issuance as a result of a currently effective registration statement relating to certain of the Company's stock option plans and the holders of substantially all of the outstanding warrants have rights to require the Company to register the underlying shares. The Company and its executive officers and directors and certain stockholders owning an aggregate of 2,117,104 shares of Common Stock and options and warrants to purchase 1,321,149 shares have agreed that they will not sell any shares of Common Stock held by them for a period of 90 days from the date of this Prospectus without the prior written consent of BT Alex. Brown Incorporated. No prediction can be made as to the effect, if any, that sales of shares of Common Stock, or the availability of such shares for sale, will have on the market prices of the Company's Common Stock prevailing from time to time. The possibility that substantial amounts of shares may be sold in the public market may adversely affect prevailing market prices for the Common Stock and could impair the Company's ability to raise capital through the sale of its equity securities. ABSENCE OF DIVIDENDS The Company has never declared or paid, nor does it intend to declare or pay in the foreseeable future, cash dividends on its Common Stock, but intends instead to retain any future earnings to finance expansion and operations. In addition, the Company's agreement with its senior bank lender contains a minimum net worth covenant and prohibits the payment of cash dividends. See "Dividend Policy" and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." UNCERTAINTIES RELATING TO YEAR 2000 CONSEQUENCES Although the Company believes that its internal management information systems are Year 2000 compliant, no assurance can be given that its business will not be adversely affected by possible Year 2000 problems of third parties. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." 10 USE OF PROCEEDS The net proceeds to the Company from this offering, after deducting estimated underwriting discounts and offering expenses, are estimated to be approximately $45.1 million ($54.6 million if the Underwriters' over-allotment option is exercised), based on an assumed public offering price of $20.13 per share. The Company will not receive any of the proceeds from the sale of shares of Common Stock by the Selling Stockholders. The Company intends to use the net proceeds of the offering to repay, without penalty, existing indebtedness primarily incurred under a credit agreement (the "Credit Agreement") with a syndicate of banks (collectively, the "Banks") that provides for: (i) an A-Term Loan Commitment of up to $29.0 million (the "A-Term Loan"); (ii) a B-Term Loan Commitment of up to $28.0 million (the "B-Term Loan"); (iii) an acquisition loan of up to $25.0 million (the "Acquisition Loan"); and (iv) a revolving loan of up to $8.0 million (the "Revolving Loan"). The Company's long-term debt at March 31, 1998, including a current portion of approximately $10.3 million, was approximately $39.6 million, with such indebtedness consisting of: (i) approximately $8.3 million borrowed under the A-Term Loan, which bears interest at the rate of 7.188% per annum and matures on December 31, 2001; (ii) approximately $8.6 million borrowed under the B-Term Loan, which bears interest at the rate of 7.438% per annum and matures on December 31, 2003; (iii) $5.0 million borrowed under the Acquisition Loan, which bears interest at the rate of 6.938% per annum and matures on November 1, 2001; (iv) $4.0 million borrowed under the Revolving Loan, which bears interest at the rate of 6.938% per annum and matures on November 1, 2001; and (v) approximately $13.7 million of other indebtedness, primarily consisting of subordinated seller notes. Of the approximately $39.6 million principal amount of existing indebtedness of the Company, the following amounts will be repaid out of the net proceeds to the Company of this offering: (i) approximately $8.3 million principal amount of the A-Term Loan; (ii) approximately $8.6 million principal amount of the B-Term Loan; (iii) $5.0 million principal amount of the Acquisition Loan; (iv) $4.0 million principal amount of the Revolving Loan; and (v) approximately $1.7 million of other indebtedness, primarily consisting of subordinated seller notes. The remaining net proceeds to the Company from this offering will be used for general corporate purposes, which may include future acquisitions. Although the Company regularly reviews strategic opportunities, the Company currently has no binding agreements with respect to any material acquisitions. 11 DIVIDEND POLICY The Company has never declared or paid, nor does it intend to declare or pay in the foreseeable future, cash dividends on the Common Stock, but intends instead to retain future earnings to finance expansion and operations. In addition, certain financial covenants in the Company's loan agreement with the Banks limit the ability of the Company to pay dividends or make other distributions on the Common Stock. PRICE RANGE OF COMMON STOCK The Common Stock of the Company has been included for quotation on the American Stock Exchange under the symbol "HGR" since April 1991. The following table sets forth the high and low intra-day sale prices for the Common Stock for the periods indicated as reported on the AMEX:
HIGH LOW ------ ------ YEAR ENDED DECEMBER 31, 1996 First Quarter.................................................. $ 4.75 $ 2.63 Second Quarter................................................. 6.50 4.06 Third Quarter.................................................. 7.50 4.88 Fourth Quarter................................................. 7.38 5.81 YEAR ENDED DECEMBER 31, 1997 First Quarter.................................................. $ 7.00 $ 5.50 Second Quarter................................................. 9.25 6.25 Third Quarter.................................................. 14.94 8.44 Fourth Quarter................................................. 14.63 10.56 YEAR ENDED DECEMBER 31, 1998 First Quarter.................................................. $17.63 $12.25 Second Quarter (through June 9, 1998).......................... 21.00 16.00
On June 9, 1998, the last reported sale price was $20.13 per share. As of June 8, 1998, there were approximately 851 holders of record of the Company's Common Stock. 12 CAPITALIZATION The following table sets forth as of March 31, 1998: (i) the capitalization of the Company; (ii) the capitalization of the Company on a pro forma basis to reflect acquisitions completed in April and May 1998; and (iii) the capitalization of the Company on a pro forma as adjusted basis to reflect acquisitions completed in April and May 1998 and the sale by the Company of the shares of Common Stock offered hereby (based on an assumed offering price of $20.13 per share) and the application of the estimated net proceeds therefrom, all as if they occurred on March 31, 1998.
MARCH 31, 1998 ------------------------------------------------------ PRO FORMA ACTUAL PRO FORMA(1) AS ADJUSTED(2) --------------- ---------------- ------------------ (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) ------------------------------------------------------ Outstanding debt: Revolving Loan.............. $ 4,000 $ 4,000 $ -- Acquisition Loan............ 5,000 5,000 -- A-Term Loan ................ 8,296 8,296 -- B-Term Loan ................ 8,592 8,592 -- Subordinated seller notes and other indebtedness..... 13,709 14,416 12,714 --------------- --------------- --------------- Total outstanding debt.... 39,597 40,304 12,714 --------------- --------------- --------------- Mandatorily redeemable preferred stock: Class C, par value $0.01; 300 shares authorized, issued and outstanding; liquidation preference of $500 per share plus accrued dividends.................. 311 311 311 Class F, par value $0.01; 100,000 shares authorized, no shares issued and outstanding; liquidation preference of $1,000 per share plus accrued dividends.................. -- -- -- Shareholders' equity: Common stock, par value $0.01; 25,000,000 shares authorized; 15,778,996 shares issued and 15,645,501 shares outstanding on an actual and pro forma basis; 18,178,996 shares issued and 18,045,501 shares outstanding on a pro forma as adjusted basis(3)....... 158 158 182 Additional paid-in capital.... 103,496 103,496 148,586 Retained earnings............. 5,928 5,928 5,928 Treasury stock, cost--(133,495 shares)...................... (655) (655) (655) --------------- --------------- --------------- Total shareholders' equity................... 108,927 108,927 154,041 --------------- --------------- --------------- Total capitalization.... $ 148,835 $ 149,542 $ 167,066 =============== =============== ===============
- -------- (1) Gives effect to the consummation of acquisitions in April and May 1998. See "Selected Unaudited Pro Forma Condensed Consolidated Financial Information." (2) Gives effect to the application of the net proceeds from the sale by the Company of 2,400,000 shares of Common Stock offered hereby at an assumed public offering price of $20.13. See "Use of Proceeds." (3) Excludes: (i) 379,808 shares of Common Stock issuable upon the exercise of stock options outstanding under the Company's 1991 Stock Option Plan at a weighted average exercise price of $6.98 per share at March 31, 1998; (ii) 56,250 shares of Common Stock issuable upon the exercise of stock options outstanding under the Company's 1993 Non-Employee Director Stock Option Plan at a weighted average exercise price of $5.70 per share; (iii) 20,375 shares of Common Stock issuable upon the exercise of outstanding non- qualified options at a weighted average exercise price of $8.46 per share; and (iv) 1,190,649 shares of Common Stock issuable upon the exercise of outstanding warrants at a weighted average exercise price of $5.37 per share. 13 SELECTED HISTORICAL AND PRO FORMA CONSOLIDATED FINANCIAL INFORMATION The following table sets forth selected historical and pro forma consolidated financial information of the Company: (i) as of December 31, 1996 and 1997 and for each of the five fiscal years ended December 31, 1997, which information has been derived from the audited consolidated financial statements of the Company; and (ii) as of March 31, 1998 and for the three months ended March 31, 1997 and 1998, which information has been derived from the consolidated financial statements of the Company which are unaudited but which, in the opinion of management, have been prepared on the same basis as the audited consolidated financial statements and include all adjustments necessary (consisting of normal recurring adjustments) for a fair presentation of the results for such periods. The results of operations for the quarter ended March 31, 1998 are not necessarily indicative of the results to be expected for the entire year ending December 31, 1998, or any future period. The selected consolidated financial data are qualified by, and should be read in conjunction with, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Prospectus. The following selected pro forma consolidated financial information should be read in conjunction with the Pro Forma Condensed Consolidated Financial Statements for the year ended December 31, 1997 and the three months ended March 31, 1998, and the Notes thereto included elsewhere in this Prospectus. The pro forma adjustments are described in the accompanying Notes to the Pro Forma Condensed Consolidated Financial Statements. 14 SELECTED HISTORICAL AND CONSOLIDATED FINANCIAL INFORMATION (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31, QUARTERS ENDED MARCH 31, ------------------------------------------------------- --------------------------- PRO FORMA PRO FORMA AS AS ADJUSTED ADJUSTED 1993 1994 1995 1996 1997 1997(4) 1997 1998 1998(5) ------- ------- ------- ------- -------- --------- ------- ------- --------- STATEMENTS OF INCOME DATA: Net sales.............. $43,877 $50,300 $52,468 $66,806 $145,598 $170,647 $30,950 $40,750 $43,052 Gross profit........... 24,207 27,091 27,896 34,573 72,064 85,201 14,720 19,447 20,628 Selling, general and administrative........ 17,124 21,340 19,362 24,550 49,076 58,551 10,925 14,729 15,713 Depreciation and amortization.......... 2,656 3,137 2,691 2,848 4,681 4,438 1,159 1,260 1,323 Acquisition and integration costs(1).. -- -- -- 2,479 -- -- -- -- -- Restructuring cost(1).. -- 460 -- -- -- -- -- -- -- Loss from disposal of assets(1)............. -- 2,150 -- -- -- -- -- -- -- Income from continuing operations............ 4,428 4 5,843 4,695 18,308 22,213 2,636 3,458 3,591 Interest expense....... (1,167) (1,746) (2,056) (2,547) (4,932) (4,694) (1,527) (615) (266) Income (loss) from continuing operations before taxes, extraordinary item and accounting change..... 3,221 (1,922) 3,680 1,971 13,166 17,269 1,065 2,873 3,358 Provision for income taxes................. 1,626 358 1,544 890 5,526 7,249 447 1,178 1,377 Income (loss) from continuing operations before extraordinary item and accounting change................ 1,594 (2,280) 2,135 1,081 7,640 10,020 618 1,695 1,981 Loss from discontinued operations(2)......... (105) (407) -- -- -- -- -- -- -- Income (loss) before extraordinary item and accounting change..... 1,490 (2,687) 2,135 1,081 7,640 10,020 618 1,695 1,981 Extraordinary loss on early extinguishment of debt............... (23) -- -- (83) (2,694) -- -- -- -- Cumulative effect of change in accounting for income taxes...... 1,189 -- -- -- -- -- -- -- -- Net income (loss)...... $ 2,655 $(2,687) $ 2,135 $ 998 $ 4,946 $ 10,020 $ 618 $ 1,695 $ 1,981 Basic per common share data(3): Income (loss) from continuing operations before extraordinary item and accounting change................ $ 0.19 $ (0.28) $ 0.25 $ 0.12 $ 0.65 $ 0.70 $ 0.07 $ 0.11 $ 0.11 Loss from discontinued operations............ (0.01) (0.05) -- -- -- -- -- -- -- Extraordinary loss on early extinguishment of debt............... -- -- -- (0.01) (0.23) -- -- -- -- Cumulative effect of change in accounting for income taxes...... 0.14 -- -- -- -- -- -- -- -- ------- ------- ------- ------- -------- -------- ------- ------- -------- Net income (loss) per common share.......... $ 0.32 $ (0.33) $ 0.25 $ 0.11 $ 0.42 $ 0.70 $ 0.07 $ 0.11 $ 0.11 ======= ======= ======= ======= ======== ======== ======= ======= ======== Shares used to compute basic per common share amounts............... 8,217 8,290 8,291 8,470 11,793 14,216 9,359 15,576 17,976 Diluted per common share data(3): Income (loss) from continuing operations before extraordinary item and accounting change................ $ 0.19 $ (0.28) $ 0.25 $ 0.12 $ 0.58 $ 0.64 $ 0.06 $ 0.10 $ 0.10 Loss from discontinued operations............ (0.01) (0.05) -- -- -- -- -- -- -- Extraordinary loss on early extinguishment of debt............... -- -- -- (0.01) (0.21) -- -- -- -- Cumulative effect of change in accounting for income taxes...... 0.14 -- -- -- -- -- -- -- -- ------- ------- ------- ------- -------- -------- ------- ------- -------- Net income (loss) per common share.......... $ 0.32 $ (0.33) $ 0.25 $ 0.11 $ 0.37 $ 0.64 $ 0.06 $ 0.10 $ 0.10 ======= ======= ======= ======= ======== ======== ======= ======= ======== Shares used to compute diluted per common share amounts......... 8,267 8,290 8,300 8,663 13,138 15,561 9,941 17,082 19,482
15
DECEMBER 31, MARCH 31, ----------------- MARCH 31, 1998 1996 1997 1998 AS ADJUSTED(6) -------- -------- --------- -------------- BALANCE SHEET DATA: Cash and cash equivalents........... $ 6,572 $ 6,557 $ 5,653 $ 22,222 Working capital..................... 25,499 39,031 35,856 59,030 Total assets........................ 134,941 157,983 169,407 187,745 Long-term debt...................... 64,298 23,237 29,286 8,869 Shareholders' equity................ 39,734 106,320 108,927 154,041
- -------- (1) The 1994 results include restructuring costs of $460,000 associated with the closing of unprofitable patient-care centers and a loss from the disposal of assets of $2.2 million resulting from the sale of the Company's southern California patient-care centers. The 1996 results include acquisition and integration costs of $2.5 million incurred in connection with the purchase of JEH effective November 1, 1996. (2) Loss from discontinued operations consists of the loss from discontinued operations and the sale of the discontinued operation of the Company's Apothecaries, Inc. subsidiary, the assets of which were sold in 1994. (3) During the fourth quarter of 1997, the Company adopted the provisions of SFAS 128 and, as required, has restated all prior period per common share data. 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 and stock warrants and are calculated using the treasury stock method. Both basic and diluted per common share amounts have been adjusted for preferred stock dividends. (4) Adjusted to give effect to: (i) acquisitions which occurred during 1997 and the five months ended May 31, 1998; and (ii) the reduction in interest expense resulting from the application of the estimated net proceeds of this offering upon the sale by the Company of 2,400,000 shares of Common Stock offered hereby at an assumed public offering price of $20.13, as if all such transactions had occurred on January 1, 1997. See "Use of Proceeds" and "Selected Unaudited Pro Forma Condensed Consolidated Financial Information." (5) Adjusted to give effect to: (i) acquisitions which occurred during the five months ended May 31, 1998; and (ii) the reduction in interest expense resulting from the application of the estimated net proceeds of this offering upon the sale by the Company of 2,400,000 shares of Common Stock offered hereby at an assumed public offering price of $20.13, as if all such transactions had occurred on January 1, 1998. See "Use of Proceeds" and "Selected Unaudited Pro Forma Condensed Consolidated Financial Information." (6) Adjusted to give effect to the sale by the Company of 2,400,000 shares of Common Stock offered hereby at an assumed public offering price of $20.13, and the application of the estimated net proceeds therefrom. See "Use of Proceeds." 16 SELECTED UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION The following unaudited pro forma condensed consolidated statement of income for the quarter ended March 31, 1998 is based on the historical financial statements of the Company, adjusted to give the effect to the acquisition of certain assets and the assumption of certain liabilities of Wayne R. Rosen C.O., C.Ped., Inc. and Orthotic Professional Services, Inc. ("Rosen"), CCMC Affiliates, Inc. ("CCMC"), Eugene Teufel and Son Orthotic and Prosthetics, Inc. ("Teufel"), Hattiesburg Braces & Limbs, Inc. ("HBL") and Augusta Brace, Inc. ("Augusta") (collectively defined as "the 1998 Acquired Companies"). The following unaudited pro forma condensed consolidated balance sheet as of March 31, 1998 is based on the historical financial statements of the Company, adjusted to give effect to the acquisition of certain assets and the assumption of certain liabilities of HBL and Augusta. The following unaudited pro forma condensed consolidated statement of income for the year ended December 31, 1997 is based on the historical financial statements of the Company, adjusted to give effect to the acquisition of certain assets and the assumption of certain liabilities of the 1998 Acquired Companies and of Prosthetic Treatment Center, Inc. ("Kingsport"), the retail division of ACOR Orthopedic, Inc. ("ACOR"), Fort Walton Orthopedic, Inc. and Mobile Limb & Brace, Inc. ("FWM"), Rehabilitation Engineering, Inc. ("REI"), Morgan Prosthetic-Orthotics, Inc. ("Morgan"), Montana Orthotics and Pros., Inc. ("Montana"), Laurence Orthopedic, Inc. ("Laurence"), Harshberger Prosthetic & Orthotic Center, Inc. et al ("Harshberger") and Reid Prosthetic Service, Inc. ("Reid") (collectively defined as "the 1997 Acquired Companies"). The unaudited pro forma condensed consolidated statement of income for the quarter ended March 31, 1998 has been prepared assuming the 1998 Acquired Companies acquisitions occurred as of January 1, 1997. The unaudited pro forma condensed consolidated statement of income for the year ended December 31, 1997 has been prepared assuming the 1998 Acquired Companies and 1997 Acquired Companies acquisitions occurred as of January 1, 1997. The unaudited pro forma condensed consolidated balance sheet as of March 31, 1998 has been prepared assuming that the HBL and Augusta acquisitions occurred on March 31, 1998. The acquisition and related adjustments are described in the notes thereto. The unaudited pro forma condensed consolidated statements of income do not purport to represent what the Company's results of operations would actually have been had the transactions in fact occurred on the aforementioned date, or to project the Company's results of operations for any future period. The pro forma adjustments are based upon available information and upon certain assumptions management believes are reasonable. These adjustments are directly attributable to the transactions and are expected to have a continuing impact on the financial condition and results of operations of the Company. The unaudited pro forma condensed consolidated statements of income should be read in conjunction with the Company's consolidated financial statements included elsewhere in this Prospectus. See "Capitalization" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." The condensed consolidated pro forma financial information does not give effect to any matters other than those described in the notes thereto. 17 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET AS OF MARCH 31, 1998
HISTORICAL ------------ HANGER ORTHOPEDIC ACQUIRED PRO FORMA OFFERING PRO FORMA GROUP, INC. COMPANIES(1) ADJUSTMENTS PRO FORMA(5) ADJUSTMENTS(6) AS ADJUSTED ------------ ------------ ----------- ------------ -------------- ------------ ASSETS Current Assets: Cash and cash equivalents........... $ 5,652,746 $ 95,825 $(1,050,825)(2)(3) $ 4,697,746 $ 17,524,550 $ 22,222,296 Accounts receivable.... 31,655,712 135,374 -- 31,791,086 -- 31,791,086 Inventories............ 17,633,551 68,184 -- 17,701,735 -- 17,701,735 Prepaid and other assets................ 4,028,619 20,558 (6,999)(2) 4,042,178 -- 4,042,178 Deferred income taxes.. 2,127,185 -- -- 2,127,185 -- 2,127,185 ------------ -------- ----------- ------------ ------------ ------------ Total Current Assets.... 61,097,813 319,941 (1,057,824) 60,359,930 17,524,550 77,884,480 ------------ -------- ----------- ------------ ------------ ------------ Property, plant and equipment, net......... 18,731,605 14,494 (4,850)(2) 18,741,249 -- 18,741,249 Intangible assets, net.. 88,613,789 2,634 1,428,534 (2)(3) 90,044,957 -- 90,044,957 Other assets............ 964,205 110,329 -- 1,074,534 -- 1,074,534 ------------ -------- ----------- ------------ ------------ ------------ Total Assets........... $169,407,412 $447,398 $ 365,860 $170,220,670 $ 17,524,550 $187,745,220 ============ ======== =========== ============ ============ ============ LIABILITIES Current Liabilities: Current portion of long-term debt........ $ 10,310,984 $ 3,230 $ 190,054 (3) $ 10,504,268 $ (6,659,396) $ 3,844,872 Accounts payable....... 3,712,060 65,395 -- 3,777,455 -- 3,777,455 Accrued expenses and other................. 11,219,119 12,641 -- 11,231,760 -- 11,231,760 ------------ -------- ----------- ------------ ------------ ------------ Total Current Liabilities............ 25,242,163 81,266 190,054 25,513,483 (6,659,396) 18,854,087 ------------ -------- ----------- ------------ ------------ ------------ Long-term debt.......... 29,286,054 53,125 460,208 (2)(3) 29,799,387 (20,930,304) 8,869,083 Deferred income taxes... 3,405,833 -- -- 3,405,833 -- 3,405,833 Other liabilities....... 2,546,595 28,605 -- 2,575,200 -- 2,575,200 ------------ -------- ----------- ------------ ------------ ------------ Total Liabilities...... 60,480,645 162,996 650,262 61,293,903 (27,589,700) 33,704,203 ------------ -------- ----------- ------------ ------------ ------------ SHAREHOLDERS' EQUITY Common stock............ 157,791 10,720 (10,720)(4) 157,791 24,000 181,791 Additional paid-in capital................ 103,496,362 7,500 (7,500)(4) 103,496,362 45,090,250 148,586,612 Retained earnings (accumulated deficit).. 5,928,176 287,330 (287,330)(4) 5,928,176 -- 5,928,176 ------------ -------- ----------- ------------ ------------ ------------ 109,582,329 305,550 (305,550) 109,582,329 45,114,250 154,696,579 Treasury stock.......... (655,562) (21,148) 21,148 (4) (655,562) -- (655,562) ------------ -------- ----------- ------------ ------------ ------------ Total Shareholders' Equity................ 108,926,767 284,402 (284,402) 108,926,767 45,114,250 154,041,017 ------------ -------- ----------- ------------ ------------ ------------ Total Liabilities and Shareholders' Equity.. $169,407,412 $447,398 $ 365,860 $170,220,670 $ 17,524,550 $187,745,220 ============ ======== =========== ============ ============ ============
See accompanying notes on the following page. 18 - -------- (1) The aggregate purchase price for the acquisitions consummated during April and May 1998 amounts to approximately $1.6 million, comprising $955,000 in cash and $670,000 in seller notes. The following represents condensed historical balance sheet information for businesses acquired during April and May 1998:
CURRENT TOTAL CURRENT TOTAL COMPANY ASSETS ASSETS LIABILITIES EQUITY ------- -------- -------- ----------- -------- HBL................................... $121,137 $123,771 $31,929 $ 39,330 Augusta............................... 198,804 323,627 49,337 245,072 -------- -------- ------- -------- Total............................... $319,941 $447,398 $81,266 $284,402 ======== ======== ======= ========
(2) The adjustment to decrease cash ($95,825); prepaid and other assets ($6,999); property, plant and equipment ($4,850); long-term debt ($53,125) and to increase intangible assets ($54,549) has been made in order to adjust assets and liabilities to fair market value and eliminate certain assets and liabilities not assumed by the Company. (3) The adjustment to decrease cash ($955,000) and to increase intangible assets ($1,658,387); the current portion of long-term debt ($190,054) and long-term debt ($513,333) has been made in order to reflect cash paid and long-term debt and seller notes incurred to purchase HBL and Augusta. (4) Reflects the elimination of ownership interests in acquired companies. (5) The unaudited pro forma condensed consolidated balance sheet excludes potential future contingent consideration to be paid to former shareholders of acquired businesses based on prescribed formulas. Contingent consideration is to be accounted for as additional purchase price consideration if and when it becomes probable. (6) Reflects the application of the estimated net proceeds of this offering as if this transaction occurred as of March 31, 1998. See "Use of Proceeds." 19 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME FOR THE QUARTER ENDED MARCH 31, 1998
HISTORICAL ----------- HANGER ORTHOPEDIC ACQUIRED PRO FORMA OFFERING PRO FORMA GROUP, INC. COMPANIES(1) ADJUSTMENTS PRO FORMA(11) ADJUSTMENTS AS ADJUSTED ----------- ------------ ----------- ------------- ----------- ----------- Net sales............... $40,750,018 $2,449,915 $(148,174)(2) $43,051,759 $ -- $43,051,759 Cost of sales........... 21,303,131 1,263,835 (143,456)(2) 22,423,510 -- 22,423,510 ----------- ---------- --------- ----------- -------- ----------- Gross profit............ 19,446,887 1,186,080 (4,718) 20,628,249 -- 20,628,249 Selling, general and administrative......... 14,729,001 1,327,596 (343,120)(3)(5) 15,713,477 -- 15,713,477 Depreciation and amortization........... 1,259,983 7,235 56,107 (4) 1,323,325 -- 1,323,325 ----------- ---------- --------- ----------- -------- ----------- Income from operations.. 3,457,903 (148,751) 282,295 3,591,447 -- 3,591,447 Interest expense, net... (614,822) 15,134 (185,247)(3)(6) (784,935) 518,460(8) (266,475) Other income............ 30,345 10,546 (7,618)(3) 33,273 -- 33,273 ----------- ---------- --------- ----------- -------- ----------- Income from operations before taxes........... 2,873,426 (123,071) 89,430 2,839,785 518,460 3,358,245 Provision for income taxes.................. 1,178,000 4,567 (18,360)(7) 1,164,207 212,569(9) 1,376,776 ----------- ---------- --------- ----------- -------- ----------- Net income.............. $ 1,695,426 $ (127,638) $ 107,790 $ 1,675,578 $305,891 $ 1,981,469 =========== ========== ========= =========== ======== =========== Basic net income per common share(10)....... $ 0.11 $ 0.11 $ 0.11 =========== =========== =========== Shares used to compute basic per common share amounts................ 15,576,030 15,576,030 17,976,030 Diluted net income per common share(10)....... $ 0.10 $ 0.10 $ 0.10 =========== =========== =========== Shares used to compute diluted per common share amounts.......... 17,081,983 17,081,983 19,481,983
See accompanying notes on the following page. 20 - -------- (1) The historical statements of income data for the 1998 Acquired Companies for the quarter ended March 31, 1998 represent the results of operations of such companies from January 1, 1998 to the earlier of their respective dates of acquisition or March 31, 1998. Each of the acquisitions has been accounted for as a purchase. Accordingly, the results of operations for each of the 1998 Acquired Companies are included in the historical results of operations of the Company from the date of its acquisition. (2) The adjustments to reduce sales ($148,174) and cost of sales ($143,456) reflect the elimination of profit on intercompany sales during the period presented. (3) The adjustments to reduce selling, general and administrative ($21,957), interest income ($14,581) and other income ($7,618) reflect the elimination of historical income and expenses generated from 1998 Acquired Companies assets not acquired. (4) Reflects increases in historical amounts of the 1998 Acquired Companies for both amortization expense resulting from the revaluation in purchase accounting of intangible assets and additional amortization over a 40- year period, as if such 1998 Acquired Companies were acquired as of the beginning of the period presented. (5) Includes a net reduction to historical amounts of $321,163 for employee and practitioner salaries of the 1998 Acquired Companies to reflect the difference between such historical amounts and amounts either specified in employment contracts for comparable employment positions with the Company or to reflect positions eliminated which will not subsequently be filled by the Company. Such employment agreements or eliminations were signed or executed concurrent with the signing of the respective purchase agreements. (6) The additional interest expense of $170,666 reflects what would have been incurred if the consideration (in the form of cash and promissory notes) for the 1998 Acquired Companies had been paid at January 1, 1998. The interest rate used to calculate pro forma interest (7.0%) on the assumed additional debt required to fund the cash payments reflects the Company's approximate borrowing rate. (7) Reflects income taxes as if the Company and the acquired companies were each a C Corporation for the period presented. (8) Reflects the application of the estimated net proceeds of this offering as if this transaction occurred as of March 31, 1998. Pro forma net interest expense, net income and net income per common share amounts do not include approximately $205,000 of interest income that would have been earned assuming the $16.6 million increase in cash had been invested in cash equivalents earning 5.0%. If interest income had been reflected, basic and diluted per common share amounts, on a pro forma as adjusted basis, would have been $0.12 and $0.11, respectively. The following reflects the debt to be repaid by the Company from the net proceeds of the offering and the debt to be outstanding as of March 31, 1998 on a pro forma as adjusted basis:
REMAINING DESCRIPTION REPAID INDEBTEDNESS ----------- ----------- ------------ Revolving Loan............ $ 4,000,000 $ -- Acquisition Loan.......... 5,955,000 -- A-Term Loan............... 8,295,967 -- B-Term Loan............... 8,591,681 -- Subordinated seller notes and other indebtedness... 1,702,052 12,710,725 ----------- ----------- Total................... $28,544,700 $12,710,725 =========== ===========
(9) Represents the adjustments to income taxes which would have been provided on a pro forma as adjusted income before income taxes basis using an effective tax rate of 41%. (10) Basic per common share amounts are computed using the weighted average number of common shares outstanding during the year. Diluted per common share amounts are computed using the weighted average number of common shares outstanding during the year and dilutive potential common shares. Dilutive potential common shares consist of stock options and stock warrants and are calculated using the treasury stock method. The shares used in computations of net income per common share on a pro forma as adjusted basis also include Common Stock being sold pursuant to this offering. Both basic and diluted per common share amounts have been adjusted for preferred dividends. (11) The unaudited pro forma amounts exclude the impact of potential future contingent consideration to be paid to former shareholders of acquired companies based on prescribed formulas. Contingent consideration is to be accounted for as additional purchase price consideration if and when it becomes probable. 21 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1997
HISTORICAL ------------ HANGER ORTHOPEDIC ACQUIRED PRO FORMA OFFERING PRO FORMA GROUP, INC. COMPANIES(1) ADJUSTMENTS PRO FORMA(11) ADJUSTMENTS AS ADJUSTED ------------ ------------ ----------- ------------- ----------- ------------ Net sales............... $145,597,876 $26,027,048 $ (978,387)(2) $170,646,537 $ -- $170,646,537 Cost of sales........... 73,533,398 12,858,949 (947,235)(2) 85,445,112 -- 85,445,112 ------------ ----------- ----------- ------------ ---------- ------------ Gross profit............ 72,064,478 13,168,099 (31,152) 85,201,425 -- 85,201,425 Selling, general and administrative......... 49,075,956 11,333,930 (1,859,043)(3)(5) 58,550,843 -- 58,550,843 Depreciation and amortization........... 4,680,822 396,091 (639,369)(4) 4,437,544 -- 4,437,544 ------------ ----------- ----------- ------------ ---------- ------------ Income from operations.. 18,307,700 1,438,078 2,467,260 22,213,038 -- 22,213,038 Interest expense........ (4,932,385) (5,213) (2,192,873)(3)(6) (7,130,471) 2,436,560(8) (4,693,911) Other income (expense), net.................... (209,296) (11,766) (28,902)(3) (249,964) -- (249,964) ------------ ----------- ----------- ------------ ---------- ------------ Income from operations before taxes and extraordinary item..... 13,166,019 1,421,099 245,485 14,832,603 2,436,560 17,269,163 Provision for income taxes.................. 5,526,000 21,298 678,668 (7) 6,225,966 1,023,355(9) 7,249,321 ------------ ----------- ----------- ------------ ---------- ------------ Net income (loss) before extraordinary item..... $ 7,640,019 $ 1,399,801 $ (433,183) $ 8,606,637 $1,413,205 $ 10,019,842 ============ =========== =========== ============ ========== ============ Basic net income per common share(10)....... $ 0.65 $ 0.73 $ 0.70 ============ ============ ============ Shares used to compute basic per common share amounts ............... 11,792,892 11,815,985 14,215,985 Diluted net income per common share(10)....... $ 0.58 $ 0.65 $ 0.64 ============ ============ ============ Shares used to compute diluted per common share amounts.......... 13,138,377 13,161,470 15,561,470
See accompanying notes on the following page. 22 - -------- (1) The historical statements of income for the 1997 Acquired Companies and the 1998 Acquired Companies for the year ended December 31, 1997 represent the results of operations for such companies from January 1, 1997 to the earlier of their respective dates of acquisition or December 31, 1997. Each of the acquisitions has been accounted for as a purchase. Accordingly, the results of operations for each of the 1997 Acquired Companies and the 1998 Acquired Companies are included in the historical results of operations of the Company from the date of its acquisition. (2) The adjustments to reduce sales ($978,387) and cost of sales ($947,235) reflect the elimination of profit on intercompany sales during the period presented. (3) The adjustments to reduce selling, general and administrative ($204,764), interest income ($48,654) and other income ($28,902) reflect the elimination of historical income and expenses generated from the 1997 Acquired Companies and 1998 Acquired Companies assets not acquired. (4) Reflects increases in historical amounts of the 1997 Acquired Companies and the 1998 Acquired Companies for both amortization expense resulting from the revaluation in purchase accounting of intangible assets and additional amortization over a 40-year period, as if such 1997 Acquired Companies and 1998 Acquired Companies were acquired as of the beginning of the period presented. (5) Includes a net reduction to historical amounts of $1,654,279 for employee and practitioner salaries of the 1997 Acquired Companies and the 1998 Acquired Companies to reflect the difference between such historical amounts and amounts either specified in employment contracts for comparable employment positions with the Company. Such employment agreements or eliminations were signed or executed concurrent with the signing of the respective purchase agreements. (6) The additional interest expense of $2,144,219 reflects what would have been incurred if the consideration (in the form of cash and promissory notes) for the 1997 Acquired Companies and the 1998 Acquired Companies had been paid at January 1, 1997. The interest rate used to calculate pro forma interest (approximately 7.7%) on the assumed additional debt required to fund the cash payments reflects the Company's approximate borrowing rate. (7) Reflects income taxes as if the Company and the acquired companies were each a C Corporation for the period presented. (8) Represents the assumed application of estimated net proceeds of this offering as of the beginning of the period presented. Pro forma net interest expense, net income and net income per common share amounts do not include approximately $730,000 of interest income that would have been earned assuming the $14.6 million increase in cash had been invested in cash equivalents earning 5.0%. If interest income had been reflected, basic and diluted per common share amounts, on a pro forma as adjusted basis, would have been $0.73 and $0.67, respectively. The following reflects the debt to be repaid by the Company from the net proceeds of this offering and the debt to be outstanding as of December 31, 1997 on a pro forma as adjusted basis:
REMAINING DESCRIPTION REPAID INDEBTEDNESS ----------- ----------- ------------ Acquisition Loan.......... $11,434,403 $ -- A-Term Loan............... 8,567,704 -- B-Term Loan............... 8,663,611 -- Subordinated seller notes and other indebtedness... 1,888,598 13,323,660 ----------- ----------- Total................... $30,554,316 $13,323,660 =========== ===========
(9) Represents the adjustments to income taxes which would have been provided on a pro forma as adjusted income before income taxes basis using an effective tax rate of 42%. (10) Basic per common share amounts are computed using the weighted average number of common shares outstanding during the year. Diluted per common share amounts are computed using the weighted average number of common shares outstanding during the year and dilutive potential common shares. Dilutive potential common shares consist of stock options and stock warrants and are calculated using the treasury stock method. The shares used in computations of net income per common share on a pro forma as adjusted basis also include Common Stock being sold pursuant to this offering. Both basic and diluted per common share amounts have been adjusted for preferred dividends. (11) The unaudited pro forma amounts exclude the impact of potential future contingent consideration to be paid to former shareholders of acquired companies based on prescribed formulas. Contingent consideration is to be accounted for as additional purchase price consideration if and when it becomes probable. 23 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion is qualified in its entirety by the more detailed information and the Consolidated Financial Statements and Notes thereto appearing elsewhere in this Prospectus. OVERVIEW The significant growth in the Company's O&P professional practice management net sales has resulted from an aggressive program of acquiring and developing O&P patient-care centers. Similarly, growth in the Company's O&P distribution and manufacturing net sales is attributable primarily to acquisitions. Since 1986, when the Company acquired its first O&P practice, the Company has acquired over 60 businesses and presently owns and operates 240 patient-care centers, six distribution facilities, three of which contain central fabrication operations, and two manufacturing facilities. Since 1995, the Company has significantly expanded OPNET, its national O&P preferred provider network, in order to facilitate contracting with managed care organizations on a national level. COMPANY EXPANSION During late 1994 and 1995, the Company closed or sold nine unprofitable patient-care centers and temporarily discontinued its acquisition program. Following a change in executive management in mid-1995 and a refinancing in 1996, the Company's acquisition program was resumed. The significant increase in the number of patient-care centers and certified practitioners in 1996 is attributable primarily to the Company's acquisition of JEH. The following table sets forth the number of patient-care centers, certified practitioners and states (including the District of Columbia) in which the Company operated at the end of each of the past five years and at March 31, 1997 and 1998:
DECEMBER 31, MARCH 31, ------------------------ --------- 1993 1994 1995 1996 1997 1997 1998 ---- ---- ---- ---- ---- ---- ---- Number of patient-care centers.............. 72 85 84 178 213 178 238 Number of certified practitioners........... 104 125 119 199 248 197 278 Number of states (including D.C.)........... 22 25 24 29 30 29 30
NON-RECURRING CHARGES The Company's results of operations prior to 1997 were adversely affected by certain non-recurring charges, the most significant of which were associated with: (i) the sale or closure of unprofitable patient-care centers and related restructuring charges recorded in 1994; and (ii) non-recurring acquisition and integration costs incurred in 1996 in connection with the acquisition of JEH.
YEARS ENDED DECEMBER 31, ----------------------------------- 1993 1994 1995 1996 1997 ------ ------ ------ ------ ------- (IN THOUSANDS) Income from continuing operations (as reported)................................ $4,428 $ 4 $5,843 $4,695 $18,308 Nature of non-recurring charges: Loss from disposal of assets............ -- 2,150 -- -- -- Restructuring costs..................... -- 460 -- -- -- Acquisition and integration costs....... -- -- -- 2,479 -- ------ ------ ------ ------ ------- Income from continuing operations (excluding non-recurring charges)........ $4,428 $2,614 $5,843 $7,174 $18,308
RECENT ACQUISITIONS During 1997, the Company acquired nine O&P companies for an aggregate consideration, excluding potential earn-out provisions, of $21.4 million. These O&P companies, which operate 29 patient-care centers and 24 employ 175 persons, had combined net sales of $19.2 million in the year ended December 31, 1997. During the five months ended May 31, 1998, the Company acquired five O&P companies for an aggregate consideration, excluding potential earn-out provisions, of approximately $14.9 million. These O&P companies, which operate 25 patient-care centers and employ 110 persons, had combined net sales of approximately $14.6 million in the year ended December 31, 1997. SAME-CENTER SALES GROWTH In addition to acquisitions of new patient-care centers, the growth in the Company's net sales from O&P patient-care services is attributable to a lesser degree to increases in net sales from existing patient-care centers. In 1994, the Company's decline in same-center net sales growth was primarily a result of poor operating performance at several centers that the Company subsequently sold or closed, the loss of several practitioners and severe weather conditions in the first quarter. The following table sets forth, for the periods indicated, the percent increase (decrease) in net sales contributed by those patient-care centers that were open during the entire period as well as the prior year's entire comparable period:
QUARTERS ENDED YEARS ENDED DECEMBER 31, MARCH 31, --------------------------- ----------- 1993 1994 1995 1996 1997 1997 1998 ---- ------ ---- ---- ----- ----- ----- Percent increase (decrease) in same- center sales......................... 4.4% (3.7)% 5.2% 5.8% 11.7% 10.6% 13.8%
CENTER-LEVEL RESULTS BY YEAR The Company generally experiences rapid growth in net sales in the first two calendar years following an acquisition or a new patient-care center opening, with rates of growth moderating in the following years. The following table represents the aggregate net sales growth of the Company's patient-care centers that have been acquired or opened since 1990:
YEAR 1(1) YEAR 2 YEAR 3 YEAR 4 YEAR 5 --------- ------ ------ ------ ------ Aggregate net sales growth................ 12.7% 7.5% 1.1% 0.1% 5.6%
- -------- (1) Year 1 represents the second full year of operation by the Company following the center's acquisition or opening divided by the first full year of operation by the Company. The Company also tracks profitability as measured by center-level EBITDA contribution before corporate overhead allocation, as shown in the following table:
YEAR 1(2) YEAR 2 YEAR 3 YEAR 4 YEAR 5 --------- ------ ------ ------ ------ EBITDA contribution margin................ 23.5% 19.7% 23.9% 21.5% 24.9%
- -------- (2) Year 1 represents the first full year of operations by the Company following the center's acquisition or opening. EBITDA contribution margin is defined as net income (loss) before interest expense, taxes, depreciation and amortization, discontinued operations, non-recurring charges, extraordinary item and accounting change as a percent of center- level net sales. Aggregate net sales growth for year 3 and 4, and EBITDA contribution margin for year 4, were negatively affected due to the underperformance in the years ended December 31, 1994 and 1995 of centers acquired in 1990 and 1991, respectively. This underperformance is primarily attributable to the loss of certain O&P practitioners and the underperformance by certain of the Company's patient-care centers. As previously discussed, the Company closed or sold nine unprofitable patient-care centers and replaced previously vacant practitioner positions beginning in late 1994 through 1995. SOURCES OF NET SALES Although the Company's net sales continue to be most significantly derived from O&P practice management activities, including patient-care services, the percent of the Company's total net sales attributable to O&P distribution activities has increased. The following table sets forth the percent contributed to net sales in each of the periods indicated by the principal sources of the Company's net sales. The increase in the 25 percent of net sales contributed by distribution activities in 1997 is attributable to the Company's acquisition of JEH in late 1996 and increased sales to O&P practitioners in the Company's OPNET network. Manufacturing as a percent of net sales declined to 5.3% in 1997 versus 12.0% in 1996. However, there was a slight increase in the actual dollar amount of net sales attributable to manufacturing.
QUARTERS ENDED YEARS ENDED DECEMBER 31, MARCH 31, ---------------------------------- ------------- 1993 1994 1995 1996 1997 1997 1998 ------ ------ ------ ------ ------ ------ ------ Sources of net sales: Practice management and patient-care services...... 76.8% 78.0% 78.5% 78.2% 77.1% 74.6% 79.0% Manufacturing............... 18.3 17.6 16.3 12.0 5.3 6.3 4.2 Distribution................ 4.9 4.4 5.2 9.8 17.6 19.1 16.8 ------ ------ ------ ------ ------ ------ ------ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% ====== ====== ====== ====== ====== ====== ======
PAYOR MIX The Company receives payments for O&P services rendered to patients from private insurers, HMOs, PPOs, the patients directly and governmental payors, including Medicare, Medicaid and the VA. The sources and amounts of the Company's net sales derived from its patient-care centers are determined by a number of factors, including the number and nature of O&P services rendered and the rates of reimbursement among payor categories. Generally, private insurance and other third-party reimbursement levels are greater than managed care (HMO/PPO), Medicare, Medicaid and VA reimbursement levels. Changes in the Company's payor mix can affect its profitability. The following table sets forth the percent contributed to net sales in each of the following periods by the principal categories of payors:
QUARTERS YEARS ENDED ENDED DECEMBER 31, MARCH 31, ------------- ------------- 1996 1997 1997 1998 ------ ------ ------ ------ Payor mix(1): Private pay and other............................. 43.2% 38.0% 43.0% 48.0% Medicare/Medicaid/VA.............................. 56.8 62.0 57.0 52.0 ------ ------ ------ ------ 100.0% 100.0% 100.0% 100.0% ====== ====== ====== ======
- -------- (1) Payor mix data for the years ended December 31, 1996 and 1997 and for the quarters ended March 31, 1997 and 1998 is based on a sampling of approximately 75% of the patient-care centers in each of such years. EBITDA AND OPERATING MARGIN TRENDS The Company's EBITDA and operating margins have fluctuated over the past five years. In 1994, margins decreased due to the loss of several practitioners, poor operating performance at several centers and severe weather in the first quarter of the year. In 1995, margins increased to 1993 levels due to the sale and/or closing of the unprofitable practices. In 1996, margins declined slightly compared to 1995 as a result of the JEH acquisition. JEH derived a larger percent of its net sales from distribution as compared to the Company, and its distribution operations had lower gross profit margins than its patient-care services. Also causing the decline in margins in 1996 was a decision by the management of the Company not to eliminate any duplicative expenses during the two months ended December 31, 1996 following the JEH acquisition. Exclusive of the JEH acquisition, EBITDA margins increased in 1996 as compared to 1995. In 1997, margins were higher than 1996 primarily from the integration of JEH and the elimination of duplicative expenses. In the first quarter of the year, margins are typically lower than full-year margins due to seasonal trends in the O&P industry. The EBITDA margin in the first quarter of 1998 decreased compared to the first quarter of 1997 as a result of the increase in the provision for bad debt expense as a percent of net sales. The following table tracks the trends in the Company's EBITDA and operating margins: 26
QUARTERS ENDED YEARS ENDED DECEMBER 31, MARCH 31, ----------------------------- ----------- 1993 1994 1995 1996 1997 1997 1998 ----- ----- ----- ----- ----- ----- ----- EBITDA margin......................... 16.1% 11.1% 16.1% 14.7% 15.6% 12.1% 11.7% Operating margin...................... 10.1% 5.2% 11.1% 10.7% 12.6% 8.5% 8.5%
SEASONALITY The Company's results of operations are affected by seasonal considerations. The adverse weather conditions often experienced in certain geographic areas of the United States during the first quarter of each year, together with a greater degree of patients' sole responsibility for their insurance deductible payment obligations during the beginning of each calendar year, have contributed to lower Company net sales during that quarter. RESULTS OF OPERATIONS The following table sets forth for the periods indicated certain items of the Company's statements of income as a percent of the Company's net sales:
YEARS QUARTERS ENDED ENDED DECEMBER 31, MARCH 31, -------------------- --------------- 1995 1996 1997 1997 1998 ------ ------ ------ ------- ------- Net sales................................ 100.0% 100.0% 100.0% 100.0% 100.0% Cost of products and services sold....... 46.8 48.2 50.5 52.4 52.3 Gross profit............................. 53.2 51.8 49.5 47.6 47.7 Selling, general and administrative...... 36.9 36.7 33.7 35.3 36.1 Depreciation and amortization............ 3.8 3.0 2.0 2.4 1.7 Amortization of excess cost over net assets acquired......................... 1.3 1.2 1.2 1.3 1.4 Acquisition and integration costs........ -- 3.7 -- -- -- Income from operations................... 11.1 7.0 12.6 8.5 8.5 Interest expense......................... 3.9 3.8 3.4 4.9 1.5 Income before taxes and extraordinary item.................................... 7.0 3.0 9.0 3.4 7.1 Provision for income taxes............... 2.9 1.3 3.8 1.4 2.9 Net income............................... 4.1% 1.5% 3.4% 2.0% 4.2%
THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THREE MONTHS ENDED MARCH 31, 1997 Net Sales. Net sales for the three months ended March 31, 1998 were approximately $40.8 million, an increase of approximately $9.8 million, or 31.7%, over net sales of approximately $30.9 million for the three months ended March 31, 1997. Contributing to the increase were: (i) a 13.8% increase in sales by those Hanger patient-care centers operating in both periods ("same-center sales"); and (ii) sales by patient-care centers acquired by Hanger subsequent to March 31, 1997. Gross Profit. Gross profit during the three months ended March 31, 1998 was approximately $19.4 million, an increase of approximately $4.7 million, or 32.1%, over gross profit of approximately $14.7 million for the three months ended March 31, 1997. Gross profit as a percent of net sales for the three months ended March 31, 1998 and 1997 remained approximately the same at 47.7% and 47.6%, respectively. Selling, General and Administrative. Selling, general and administrative expenses in the three months ended March 31, 1998 were approximately $14.7 million, an increase of approximately $3.8 million, or 34.8%, compared to $10.9 million for the three months ended March 31, 1997. The increase in selling, general and administrative expenses was primarily a result of the Company's acquisition program. Selling, general and administrative expenses as a percent of net sales for the three months ended March 31, 1998 and 1997 increased to 36.1% from 35.3%, respectively. 27 Income from Operations. Principally as a result of the above, income from operations in the three months ended March 31, 1998 was approximately $3.5 million, an increase of approximately $822,000, or 31.2%, over income from operations of $2.6 million for the three months ended March 31, 1997. Income from operations as a percent of net sales for the three months ended March 31, 1998 and 1997 remained the same at 8.5%. Interest Expense. Interest expense in the first three months of 1998 was approximately $615,000, a decrease of approximately $912,000, or 59.7%, from the approximately $1.5 million of interest expense incurred in the first three months of 1997. Interest expense as a percent of net sales for the three months ended March 31, 1998 and 1997 decreased to 1.5% from 4.9%, respectively. The decrease was primarily attributable to the repayment of $58.0 million of indebtedness in July and August 1997 using the net proceeds of an underwritten public offering in which the Company sold 5,750,000 shares of Common Stock at $11.00 per share. Provision for Income Taxes. The Company's effective tax rate was 41% in the first three months of 1998 versus 42% for the first three months of 1997. The provision for income taxes in the first three months of 1998 was approximately $1.2 million compared to approximately $447,000 in the first three months of 1997. Net Income. As a result of the above, the Company recorded net income of approximately $1.7 million, or $0.10 per common dilutive share on approximately 17,082,000 shares outstanding for the three months ended March 31, 1998, compared to net income of approximately $618,000, or $0.06 per common dilutive share on approximately 9,941,000 shares outstanding in the three months ended March 31, 1997. YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996 Net Sales. Net sales for the year ended December 31, 1997 were approximately $145.6 million, an increase of approximately $78.8 million, or 117.9%, over net sales of approximately $66.8 million for the year ended December 31, 1996. The increase was primarily a result of: (i) the acquisition of J.E. Hanger, Inc. of Georgia ("JEH") on November 1, 1996, as well as other acquisitions during 1997; and (ii) an 11.7% increase in net sales attributable to patient- care centers and facilities operating during both periods. Gross Profit. Gross profit for the year ended December 31, 1997 was approximately $72.1 million, an increase of approximately $37.5 million, or 108.4%, over gross profit of approximately $34.6 million for the year ended December 31, 1996. The cost of products and services sold for the year ended December 31, 1997 was approximately $73.5 million compared to $32.2 million for the year ended December 31, 1996. Gross profit as a percent of net sales for patient-care services for the years ended December 31, 1997 and 1996 remained the same at 55.1%. Gross profit as a percent of net sales for manufacturing and distribution was 44.9% and 16.0% for those years, respectively. The total Company gross profit as a percent of net sales declined from 51.8% in 1996 to 49.5% in 1997. The 2.3% decrease in the Company's gross profit as a percent of net sales is primarily attributable to the acquisition of JEH, which operated a large distribution division that had lower gross profit margins than those of patient-care services. Selling, General and Administrative. Selling, general and administrative expenses for the year ended December 31, 1997 were approximately $49.1 million, an increase of approximately $24.5 million, or 99.9%, compared to approximately $24.5 million for the year ended December 31, 1996. The increase in selling, general and administrative expenses was primarily a result of the acquisition of JEH and other acquisitions. Selling, general and administrative expenses as a percent of net sales decreased to 33.7% in 1997 from 36.7% in 1996. The selling, general and administrative expenses as a percent of net sales decreased primarily as a result of cost- cutting measures completed during the fourth quarter of 1996 and the first six months of 1997. Income from Operations. Principally as a result of the above, income from operations for the year ended December 31, 1997 was approximately $18.3 million, an increase of $13.6 million, or 290.0%, compared to approximately $4.7 million for the year ended December 31, 1996. Income from operations as a percent of net sales increased to 12.6% in 1997 from 7.0% in 1996. Interest Expense. Interest expense for the year ended December 31, 1997 was approximately $4.9 million, an increase of approximately $2.4 million, or 93.7%, compared to approximately $2.5 million of interest expense incurred during the year ended December 31, 1996. Interest expense as a percent of net sales decreased to 3.4% 28 in 1997 from 3.8% for 1996. The increase in interest expense was primarily attributable to the increase in bank debt resulting from the acquisition of JEH in November 1996, which was offset in part by the repayment of bank debt out of the proceeds of the public equity offering in the third quarter of 1997. Provision for Income Taxes. The Company's effective tax rate was 42% in 1997 versus 45% in 1996. The decrease in 1997 is a result of the disproportionate impact of the amortization of the excess costs over net assets acquired in relation to taxable income in 1996. Extraordinary Item. A pre-tax extraordinary item of $4.6 million ($2.7 million, net of tax benefit) in 1997, represents entirely a write-off of debt issue costs and debt discount as a result of extinguishing approximately $58.3 million of bank debt from the net proceeds of the third-quarter public equity offering. Net Income. As a result of the above, the Company recorded net income from operations before extraordinary item of $7.6 million for the year ended December 31, 1997, compared to $1.1 million for the prior year. A pre-tax extraordinary item of $4.6 million ($2.7 million, net of tax benefit) on early extinguishment of debt was recognized in 1997 compared to $139,000 ($83,000, net of tax benefit) in 1996. Both extraordinary items were in connection with refinancings of bank indebtedness. As a result of the above, the Company reported net income of $4.9 million, or $0.37 per common dilutive share, for the year ended December 31, 1997, as compared to net income of $998,000, or $0.11 per common dilutive share, for the year ended December 31, 1996. YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995 Net Sales. Net sales for the year ended December 31, 1996 were approximately $66.8 million, an increase of approximately $14.3 million, or 27.3%, over net sales of approximately $52.5 million for the year ended December 31, 1995. The increase was primarily a result of: (i) an increase of $12.1 million attributable to the acquisition of JEH; and (ii) an increase of $2.2 million, or 5.6%, in net sales attributable to patient-care centers and facilities that were in operation during both periods. Of the $2.2 million increase in net sales, $1.8 million was attributable to patient-care centers and $293,000 was attributable to manufacturing and distribution activities. Gross Profit. Gross profit in 1996 increased approximately $6.7 million, or 23.9%, over the prior year. Gross profit as a percent of net sales decreased from 53.2% in 1995 to 51.8% in 1996. The 1.4% decrease in gross profit as a percent of net sales is primarily attributable to the acquisition of JEH, which operated a large distribution division that had lower gross profit margins than patient-care services. The cost of products and services sold for the year ended December 31, 1996 was $32.2 million compared to $24.6 million in 1995. Selling, General and Administrative. Selling, general and administrative expenses in 1996 increased approximately $5.2 million, or 26.8%, compared to 1995. The increase in selling, general and administrative expenses was primarily a result of the acquisition of JEH. Selling, general and administrative expenses as a percent of net sales stayed approximately the same at 37%. Acquisition and Integration Costs. Non-recurring acquisition and integration costs totaling $2.5 million in 1996 consisted of: (i) $1.3 million of bonuses and legal and consulting expenses incurred to acquire JEH; and (ii) $1.2 million of costs to integrate the operations of JEH with the Company, including costs of severance and the conversion of its health insurance plan and computer systems. Income from Operations. Principally as a result of the above, income from operations in 1996 was approximately $4.7 million, a decrease of $1.1 million from the prior year. Income from operations as a percent of net sales in 1996 decreased to 7.0% from 11.1% in 1995. Interest Expense. Interest expense for the year ended December 31, 1996 was approximately $2.5 million, an increase of $490,000, or 23.9%, over the $2.1 million of interest expense incurred during the year ended December 31, 1995. The increase in interest expense was primarily attributable to the increase in bank debt resulting from the acquisition of JEH. Interest expense as a percent of net sales was 3.8% for the year ended December 31, 1996, compared to 3.9% for 1995. 29 Provision for Income Taxes. The Company's effective tax rate was 45% in 1996 versus 42% in 1995. The increase in 1996 reflects both the recognition of a state deferred tax benefit in 1995, which did not occur in 1996, and the disproportionate impact of permanent differences in relation to taxable income. Net Income. As a result of the above, the Company reported income from operations before extraordinary item and accounting change of $1.1 million for the year ended December 31, 1996, compared to $2.1 million for the prior year. A pre-tax extraordinary item of $139,000 ($83,000, net of tax benefit) on early extinguishment of debt was recognized in 1996 in connection with the Company's refinancing of bank indebtedness. As a result of the above, the Company reported net income of $998,000, or $0.11 per common dilutive share, for the year ended December 31, 1996, as compared to net income of $2.1 million, or $0.25 per common dilutive share, for the year ended December 31, 1995. PRO FORMA RESULTS FOR THE YEAR ENDED DECEMBER 31, 1997 AND THE THREE MONTHS ENDED MARCH 31, 1998 The Unaudited Pro Forma Condensed Consolidated Statements of Income for the year ended December 31, 1997 and the three months ended March 31, 1998 are based on the historical consolidated statements of income of the Company, adjusted to give effect to the acquisitions of both the 1997 Acquired Companies and the 1998 Acquired Companies. The Unaudited Pro Forma Condensed Consolidated Statements of Income for the year ended December 31, 1997 and the three months ended March 31, 1998 have been prepared assuming such acquisitions occurred as of January 1, 1997. The Unaudited Pro Forma Condensed Consolidated Statements of Income also give effect to the reduction in interest expense resulting from the expected application of the estimated net proceeds of this offering to retire certain outstanding debt of the Company as if such retirement occurred on January 1, 1997. See "Use of Proceeds." The Unaudited Pro Forma Condensed Consolidated Statements of Income do not purport to represent what the Company's results of operations would have been had the acquisitions of both the 1997 Acquired Companies and 1998 Acquired Companies occurred as of the beginning of the period presented or to project the Company's results of operations for any future date or period, nor do they give effect to any matters other than those described in the notes thereto. For a description of adjustments made to the historical financial statements, see "Selected Unaudited Pro Forma Condensed Consolidated Financial Information" and the notes thereto. The effect of the acquisitions of both the 1997 Acquired Companies and the 1998 Acquired Companies was to increase net sales by approximately $25.0 million in the year ended December 31, 1997 and $2.3 million in the three months ended March 31, 1998 above the Company's historical results for such periods. The 1997 Acquired Companies and 1998 Acquired Companies had a gross profit margin of 50.6% of net sales in the year ended December 31, 1997 and 48.4% of net sales in the three months ended March 31, 1998. Gross profit margins of the Company on a pro forma as adjusted basis were 49.9% of net sales for the year ended December 31, 1997 and 47.9% of net sales for the three months ended March 31, 1998. The Acquired Companies' selling, general and administrative expenses as a percent of net sales were 43.5% in the year ended December 31, 1997 and 54.2% of net sales for the three months ended March 31, 1998. Selling, general and administrative expenses of the Company on a pro forma as adjusted basis were 34.3% of net sales for the year ended December 31, 1997 and 36.5% of net sales for the three months ended March 31, 1998 as a result of adjustments to eliminate Acquired Company compensation, and other expenses. As a result of the above, the Company's income from operations on a pro forma as adjusted basis was 13.0% of net sales for the year ended December 31, 1997 and 8.3% for the three months ended March 31, 1998. Interest expense on a pro forma as adjusted basis decreased by approximately $238,000 for the year ended December 31, 1997 and $348,000 for the three months ended March 31, 1998 after the application of the estimated net proceeds of this offering to retire certain indebtedness. See "Use of Proceeds" and "Selected Unaudited Pro Forma Condensed Consolidated Financial Information." LIQUIDITY AND CAPITAL RESOURCES The Company's consolidated working capital at March 31, 1998 was approximately $35.9 million. Cash and cash equivalents available at that date were approximately $5.7 million. The Company's cash resources were satisfactory to meet its obligations for the three months ended March 31, 1998. 30 The Company has a credit agreement (the "Credit Agreement") with a syndicate of banks, (collectively, the "Banks") that provides for: (i) the A-Term Loan of up to $29.0 million; (ii) the B-Term Loan of up to $28.0 million; (iii) the Acquisition Loan of up to $25.0 million; and (iv) the Revolving Loan of up to $8.0 million. The Company's total long-term debt at March 31, 1998, including a current portion of approximately $10.3 million, was approximately $39.6 million. Such indebtedness included: (i) $16.9 million borrowed under the A-Term Loan and B- Term Loan; (ii) $5.0 million borrowed under the Acquisition Loan; (iii) $4.0 million borrowed under the Revolving Loan; and (iv) approximately $13.7 million of other indebtedness, primarily consisting of subordinated seller notes. The Credit Agreement with the Banks is collateralized by substantially all the assets of the Company, restricts the payment of dividends, and contains certain affirmative and negative covenants customary in an agreement of this nature. The A-Term Loan, the Acquisition Loan and the Revolving Loan bear base interest at the Company's option of either LIBOR plus 2.50% or the Bank's prime rate plus 1.50%. The base interest rate is then reduced by 0.25% to 1.25% depending upon the ratio of the Company's total indebtedness to annual earnings before interest, taxes, depreciation and amortization. The outstanding amount of the A-Term Loan at March 31, 1998 was $8.3 million, which is being amortized in quarterly amounts and will mature on December 31, 2001. The B-Term Loan bears base interest at the Company's option of either LIBOR plus 2.75% or the Bank's prime rate plus 1.75%. The base interest rate is then reduced by 0.25% to 1.25% depending upon the ratio of the Company's total indebtedness to annual earnings before interest, taxes, depreciation and amortization. The outstanding amount of the B-Term Loan at March 31, 1998 was $8.6 million, which is being amortized in quarterly amounts and will mature on December 31, 2003. All or any portion of outstanding loans under the Credit Agreement may be repaid at any time and commitments may be terminated in whole or in part at the option of the Company without premium or penalty, except that LIBOR-based loans may only be repaid at the end of the applicable interest period. Mandatory prepayments will be required in the event of certain sales of assets, debt or equity financings and under certain other circumstances. Reference is made to "Use of Proceeds" above for information regarding the Company's planned prepayment of outstanding loans under the Credit Agreement. During the first three months of 1998, the Company acquired three O&P companies. The aggregate purchase price was $13.2 million, comprised of $10.4 million in cash and $2.8 million in promissory notes. The Company plans to finance future acquisitions through internally generated funds or borrowings under the Acquisition Loan, the issuance of notes or shares of Common Stock of the Company, or through a combination thereof. The Company is actively engaged in ongoing discussions with prospective acquisition candidates. The Company plans to continue to expand its operations aggressively through acquisitions. OTHER Inflation has not had a significant effect on the Company's operations, as increased costs to the Company generally have been offset by increased prices of products and services sold. The Company will adopt the provisions of SFAS 131, "Disclosures about Segments of an Enterprise and Related Information" effective with the financial statements for the year ended December 31, 1998. SFAS 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. Financial statement disclosures for prior periods are required to be restated. The Company is in the process of evaluating the disclosure requirements. The adoption of SFAS 131 affects disclosure only and will not affect reported earnings, cash flows or financial condition. 31 The Company primarily provides services and customized devices throughout the United States and is reimbursed, in large part, by the patients' third- party insurers or governmentally funded health insurance programs. The ability of the Company's debtors to meet their obligations is principally dependent upon the financial stability of the insurers of the Company's patients and future legislation and regulatory actions. The Company's management believes that its major financial and manufacturing applications are Year 2000 compliant. The Company expects no material impact on its internal information systems from the Year 2000 issue. The Company has recently initiated communications with its significant suppliers to determine the extent that the Company may be impacted by the third parties' failure to address the issue. The Company will continue to monitor and evaluate the impact of the Year 2000 issue on its operations. 32 BUSINESS OVERVIEW Hanger Orthopedic Group, Inc. is a professional practice management company focused on the orthotic and prosthetic segment of the orthopedic rehabilitation industry. The Company acquires and operates the practices of orthotists and prosthetists, medical professionals that design, fabricate, fit and supervise the use of external musculoskeletal support devices and artificial limbs. The Company has acquired over 60 O&P businesses since 1986 and currently employs 280 certified O&P practitioners and owns and operates 240 O&P patient-care centers in 30 states and the District of Columbia. The Company has also developed OPNET, a national preferred provider network of O&P service professionals. OPNET has contractual relationships with 358 O&P patient-care centers (240 of which are owned and operated by the Company), serving 291 managed care plans. In addition to its practice management and patient-care services, the Company manufactures custom-made and prefabricated O&P devices and is the largest distributor of O&P components and finished O&P patient-care products in the United States. The combination of practice management and patient-care services, OPNET, distribution and manufacturing operations positions the Company as a fully-integrated provider of O&P services. INDUSTRY BACKGROUND Orthotics is the design, fabrication, fitting and supervised use of custom- made braces and other devices that provide external support to treat musculoskeletal disorders. Musculoskeletal disorders are ailments of the back, extremities or joints caused by traumatic injuries, chronic conditions, diseases, congenital disorders or injuries resulting from sports or other activities. Prosthetics is the design, fabrication and fitting of custom-made artificial limbs for patients who have lost limbs as a result of traumatic injuries, vascular diseases, diabetes, cancer or congenital disorders. Care of O&P patients is part of a continuum of rehabilitation services from diagnosis to treatment and prevention of future injury. This continuum involves the integration of several medical disciplines that begins with the attending physician's diagnosis. Once a course of treatment is determined, the physician, generally an orthopedic surgeon, vascular surgeon or psychiatrist, refers a patient to an O&P patient-care service provider for treatment. An O&P practitioner then consults with both the referring physician and the patient to formulate the prescription for, and design of, an orthotic or prosthetic device to meet the patient's needs. The Company estimates that the O&P patient-care services industry in the United States represented approximately $2.3 billion in sales in 1997. Key trends expected to increase the demand for O&P services include: Growing Elderly Population. The growth rate of the over-65 age group is nearly triple that of the under-65 age group. With broader medical insurance coverage, increasing disposable income, longer life expectancy, greater mobility and improved technologies and devices, the elderly are expected to seek orthopedic rehabilitation services more often. Cost-Effective Reduction in Hospitalization. As public and private payors encourage reduced hospital admissions and length of stay, outpatient rehabilitation is in greater demand. O&P services and devices have enabled patients to become ambulatory more quickly after receiving medical treatment in the hospital. The Company believes that significant cost savings can be achieved through the early use of O&P services. The provision of O&P services in many cases reduces the need for more expensive treatments, thus representing a cost savings to the third-party payor. Growing Physical Health Consciousness. There is a growing emphasis on physical fitness, leisure sports and conditioning, such as running and aerobics, which has led to increased injuries requiring orthopedic rehabilitative services and products. In addition, as the current middle-age population ages, it brings its more active life-style and accompanying emphasis on physical fitness to the over-65 age group. These trends are evidenced by the increasing demand for new devices which provide support for injuries, prevent further or new injuries or enhance physical performance. Advancing Technologies. The range and effectiveness of treatment options have increased in connection with the technological sophistication of O&P devices. Advances in design technologies and lighter, stronger and 33 more cosmetically acceptable materials have enabled the industry to produce new O&P products, which provide greater comfort, protection and patient acceptability. Therefore, treatment can be more effective and of shorter duration, contributing to greater mobility and a more active lifestyle for the patient. Orthotic devices are more prevalent and visible in many sports, including skiing, running and golf. Need for Replacement and Continuing Care. Because the useful life of most custom-fitted and fabricated O&P devices is approximately three to five years, such devices need retrofitting and replacement. There is also an attendant need for continuing patient-care services, which contributes to the increasing demand for orthopedic rehabilitation. INDUSTRY CONSOLIDATION The O&P services market is highly fragmented and relatively underpenetrated by professional practice management companies. Hanger is one of the two largest companies in the O&P industry which, combined, accounted for less that 15% of the total estimated O&P industry revenue in 1997. There are an estimated 3,300 certified prosthetists and/or orthotists and approximately 2,850 O&P patient-care centers in the United States, with such facilities generally being operated as small group practices. There are also several regional and multi-regional competitors that operate numerous patient-care centers. The Company believes that the O&P industry will continue to consolidate as a result of a variety of factors, including: Increased Managed Care Penetration. The expanding geographic reach of the large managed care organizations makes it increasingly important for them to contract for their patient-care needs with counterparts who have large, national operations. Managed care companies therefore prefer to contract with a single professional practice management company to provide all of their O&P patient-care services. As a result, small independent O&P practices feel pressure to consolidate in order to access managed care referrals. Economies of Scale. A significant portion of the cost of O&P services is attributable to the cost of materials used in orthoses and prostheses. Achieving purchase discounts through group purchasing can increase profitability at each patient-care center. In addition, economies of scale provide O&P practices with access to additional capital and personnel which can be used in growing their businesses. Financial Liquidity for O&P Practices. The security of a large O&P network is extremely appealing to small providers who desire to reduce the financial and personal liabilities of their practices. Through consolidation, individual providers are able to realize financial liquidity by turning their practices' cash flows into cash assets. This consolidation allows smaller providers to continue their O&P practices as employees of a national O&P professional practice management provider. COMPANY STRATEGY The Company's objective is to build a major national orthopedic rehabilitation company focused on the acquisition and operation of O&P practices and the manufacturing and distribution of O&P products. The Company's strategy for achieving this objective is to: . Acquire and integrate O&P practices in targeted geographic areas across the United States; . Develop new O&P patient-care centers in existing markets; . Expand and improve O&P practice management operations at existing and acquired patient-care centers; . Increase OPNET's number of O&P patient-care service members and contractual relationships with managed care organizations; and . Leverage and expand the Company's O&P manufacturing and distribution operations. Acquire and Integrate O&P Practices in Targeted Geographic Areas across the United States. The Company's expansion is focused on developing a national network providing O&P patient-care coverage. Therefore, when identifying patient-care centers for acquisition, the Company seeks to fill gaps in its existing geographic coverage. By focusing on national development, the Company is well-positioned to negotiate for national contracts as payors consolidate and look to large providers for services. 34 Develop New O&P Patient-Care Centers in Existing Markets. In addition to acquiring patient-care centers, the Company intends to open new O&P patient- care centers in existing markets. The Company plans to pursue this strategy by opening satellite centers in areas where a need for O&P services has been identified. In opening satellite patient-care centers, the Company's practice is to staff on a part-time basis with professionals from a nearby existing center so as to test the viability of a full-time practice. Expand and Improve O&P Practice Management Operations at Existing and Acquired Patient-Care Centers. As the number of Hanger patient-care centers continues to increase, the benefits of the Company's practice management operations will be maximized. The Company will be able to spread administrative fixed costs and capital expenditures for state-of-the-art equipment such as CAD/CAM systems over a large number of patient-care centers. Furthermore, sales can also be enhanced by the Company's use of marketing programs not generally utilized by practitioners in smaller, independent practices. Increase OPNET's Number of O&P Patient-Care Service Members and Contractual Relationships with Managed Care Organizations. The Company intends to expand OPNET membership towards the goal of achieving complete nationwide O&P patient-care coverage. A national network will enable OPNET to negotiate for contracts with any local, regional or national third-party payor seeking a single source O&P provider regardless of the payor's geographic scope. Leverage and Expand the Company's O&P Manufacturing and Distribution Operations. As the patient-care practice management division of the Company expands, it can create captive demand for the Company's distribution business. An increase in the number of OPNET members, to whom preferred purchasing agreements are offered, can also increase net sales for the Company's distribution business. The Company's manufacturing division can also benefit from increased net sales at the distribution division by providing proprietary products to meet the demand of an expanded captive market. The Company's manufacturing efforts will focus on the acquisition and/or development of proprietary patented products such as the Lenox Hill Knee Brace and the Charleston Bending Brace. PRACTICE MANAGEMENT AND PATIENT-CARE SERVICES Practice Management Services The Company provides all senior management, accounting, accounts payable, payroll, sales and marketing, human resources and management information systems for its patient-care centers. By providing these services on a centralized basis, the Company is able to provide such services to its patient-care centers and practitioners more efficiently and cost-effectively than if such services had to be generated at each center. The centralization of these services also permits the Company's certified practitioners to allocate a greater portion of their time to patient-care activities by reducing the administrative responsibilities of operating their businesses. Billing and collections are handled on a decentralized basis, which the Company believes enhances collectibility. The Company also develops and implements programs designed to enhance the efficiency of its clinical practices. Such programs include: (i) sales and marketing initiatives to attract new-patient referrals by establishing relationships with physicians, therapists, employers, managed care organizations, hospitals, rehabilitation centers, outpatient clinics and insurance companies; (ii) professional management and information systems to improve efficiencies of administrative and operational functions; (iii) professional education programs for practitioners emphasizing new developments in the increasingly sophisticated field of O&P clinical therapy; (iv) the regional centralization of fabrication and purchasing activities, which provides overnight access to component parts and products at prices that are typically 25% lower than traditional procurement methods; and (v) access to expensive, state-of-the-art equipment which is financially more difficult for smaller, independent facilities to obtain. The Company believes that the application of sales and marketing techniques is a key element of its O&P professional practice management strategy. Due primarily to the fragmented nature of the industry, the success of an O&P practice has been largely a function of its local reputation for quality of care, responsiveness and 35 length of service in the community. Individual practitioners have relied almost exclusively on referrals from local physicians or physical therapists and typically have not used marketing techniques. Patient-Care Services The Company provides O&P patient-care services through 240 owned and operated O&P patient-care centers in 30 states and the District of Columbia. Hanger currently employs 373 patient-care practitioners, of whom 280 are certified practitioners and 35 are candidates for formal certification by the O&P industry certifying boards. Each of the Company's patient-care centers is closely supervised by one or more certified practitioners. The balance of the Company's patient-care practitioners are highly trained technical personnel who assist in the provision of services to patients and fabricate various O&P devices. A patient is referred to one of Hanger's patient-care centers for treatment upon a determination by the attending physician of a course of treatment for a patient in need of O&P patient-care services. A Hanger practitioner then consults with both the referring physician and the patient to formulate the prescription for, and design of, an orthotic or prosthetic device to meet the patient's needs. The fitting process involves several stages in order to successfully achieve desired functional and cosmetic results. The practitioner creates a cast and takes detailed measurements of the patient to ensure an anatomically correct fit. All of the prosthetic devices fitted by Hanger's practitioners are custom designed and fabricated by skilled practitioners who can balance fit, support and comfort. Of the orthotic devices provided by Hanger, approximately 75% is custom designed, fabricated and fitted and the balance are prefabricated but custom fitted. Custom devices are fabricated by the Company's skilled technicians using castings, measurements and designs made by the practitioner. Technicians use advanced materials and technologies to fabricate a custom device under quality assurance guidelines. After final adjustments to the device by the practitioner, the patient is instructed in the use, care and maintenance of the device. A program of scheduled follow-up and maintenance visits is used to provide post-fitting treatment, including adjustments or replacements as the patient's physical condition and lifestyle change. A substantial portion of Hanger's O&P services involves treatment of a patient in a non-hospital setting, such as a Hanger patient-care center, a physician's office, an outpatient clinic or other facility. In addition, O&P services are increasingly rendered to patients in hospitals, nursing homes, rehabilitation centers and other alternate-site health care facilities. In a hospital setting, the practitioner works with a physician to provide either orthotic devices or temporary prosthetic devices that are later replaced by permanent prostheses. The Company also operates in-patient O&P patient-care centers at The Rusk Institute of Rehabilitation Medicine at the New York University Medical Center in New York, New York and the Harmarville Rehabilitation Center in Pittsburgh, Pennsylvania. OPNET In 1995, Hanger formed OPNET, a proprietary national preferred provider O&P referral network serving managed care organizations, including HMOs and PPOs. OPNET is the only PPO in the United States focusing solely on the O&P market. Through this network, managed care organizations can contract for O&P services with any O&P patient-care center in the OPNET network. OPNET has a network of 358 patient-care centers (240 of which are owned and operated by the Company), serving 291 managed care plans. The Company intends to continue to extend the network's reach nationwide through acquisitions and marketing. OPNET also provides incentives to independent O&P service provider members to purchase their O&P products from the Company. The Company receives upfront annual payments from practitioners to enter the OPNET network and OPNET does not receive payments from the managed care participants. Relationships with OPNET participants have contributed positively to same-store sales growth. In addition, OPNET has allowed the Company to leverage its existing manufacturing and distribution infrastructure and increase sales of O&P products manufactured and/or distributed by the Company. The Company believes that OPNET's membership enables it to establish significant relationships with practitioners otherwise not affiliated with the Company. 36 In February 1998, the Company signed a contract with Beverly Enterprises, Inc. to provide O&P services to patients in approximately 800 nursing homes and rehabilitation centers throughout the United States. In July 1997, the Company signed a contract to provide O&P services to FIRST HEALTH Group Corp., a major specialty managed care company focused on workers' compensation. MANUFACTURING AND DISTRIBUTION In addition to on-site fabrication of custom O&P devices incidental to the services rendered at its O&P patient-care centers, the Company manufactures O&P components and finished patient-care products for both the O&P industry and the Company's own patient-care practices. The Company manufactures components and finished products under various name brands such as Lenox Hill, CASH Brace, Ortho-Mold and Charleston Bending Brace. The principal products manufactured are prefabricated and custom-made spinal orthoses as well as custom-made and off-the-shelf derotation knee braces. The Company distributes O&P components and finished patient-care products to the O&P industry and to the Company's own patient-care practices. The Company inventories over 20,000 items, the majority of which are manufactured by other companies and are distributed by Hanger. Hanger's distribution capability allows its personnel faster access to the products needed to fabricate devices for patients. This is accomplished at competitive prices, as a result of either manufacturing by Hanger or direct purchases by Hanger from other manufacturers. As a result of faster access to products, the length of a patient's treatment in the hospital can be reduced, thereby contributing to health care cost containment. Marketing of Hanger's manufactured products and distribution services is conducted on a national basis, primarily through approximately 34 sales representatives, catalogues and exhibits at industry and medical meetings and conventions. Hanger directs specialized catalogues to segments of the health care industry, such as orthopedic surgeons and physical and occupational therapists. In addition, the Company directs its broad-based marketing to the O&P industry and the home health care industry. To provide timely custom fabrication and service to its patients, the Company employs technical personnel and maintains laboratories at each of its patient-care centers. The Company uses advanced computer-aided design and computer-aided machinery (CAD/CAM) technology to produce precise and uniform products. Hanger has several large, fully-staffed central fabrication facilities to service its patient-care centers. These strategically located facilities enable Hanger to fabricate those O&P products that are more easily produced in larger quantities and in a more cost-effective manner, as well as serving as an auxiliary production center for products normally fabricated at individual patient-care centers. ACQUISITIONS Since 1986, the Company has acquired over 60 businesses in 30 states and the District of Columbia. In November 1996, Hanger acquired JEH, a Georgia corporation that operated 96 patient-care centers in 15 states and was the country's largest distributor of O&P products. During 1997, the Company acquired nine O&P companies and the remaining 20% interest of its majority owned subsidiary, Columbia Brace, for an aggregate consideration, excluding potential earn-out provisions, of $22.5 million. These O&P companies, which operated 29 patient-care centers and employed 175 persons, had combined net sales of $19.2 million in the year ended December 31, 1997. During the five months ended May 31, 1998, the Company acquired five O&P companies for an aggregate consideration, excluding potential earn-out provisions, of approximately $14.9 million. These O&P companies, which operate 25 patient-care centers and employ 110 persons, had combined net sales of approximately $14.6 million for the year ended December 31, 1997. The Company continues to be engaged in discussions with several O&P companies relating to the Company's possible acquisition of their patient-care practices. The Company's investigations of these businesses are in the formative stages and no representations can be made as to whether, when or on what terms such possible acquisitions may be effected. 37 The Company considers both operating and financial factors in evaluating prospective acquisitions. Operating factors include high standards of professionalism and patient care, the presence of certified practitioners at each of its facilities and reputation in the O&P industry. Financial factors include earnings and cash flow history and the projected benefits of applying Hanger's operating model to the acquired company's practice. In evaluating acquisitions in geographic areas where the Company has an established presence, Hanger targets businesses that complement its existing network of patient-care centers. In geographic areas where the Company has not yet established a presence, the Company generally focuses on acquiring strong regional businesses which have multiple patient-care centers and experienced practitioners. The Company's acquisition strategy also includes the retention and support of the existing management of the acquired company, typically through the use of employment contracts, non-compete agreements and incentive programs. Upon the completion of an acquisition, the Company will integrate the business of the acquired company by: (i) transferring all administrative and financial management responsibilities to Hanger's corporate headquarters; (ii) providing all new personnel with compensation and benefit packages and training by the Company's Human Resources Department; and (iii) providing the management of the acquired company with instruction on the Company's latest marketing and sales techniques. Thereafter, the Company will provide the management and staff of the newly acquired company with financial incentives to induce greater financial performance. NEW-CENTER DEVELOPMENT In addition to acquired patient-care centers, the Company develops new satellite patient-care centers in existing markets with underserved demand for O&P services. These satellite centers require less capital to develop than complete O&P centers since the satellite centers usually consist of only a waiting room and patient fitting rooms, but without a fabrication laboratory for creating O&P devices. An O&P practitioner will spend one or two days each week in a satellite center treating those patients who find it inconvenient to visit the O&P practitioner's primary center. These satellite centers also tend to receive new patient referrals from hospitals and physicians located near the newly-developed center, driving new patient growth and center net sales. While a partial net sales shift occurs from the O&P practitioner's main center to the satellite center because the O&P practitioner is now seeing some of the same patients out of a new center, the additional patient volume in the satellite center increases the O&P practitioner's overall net sales. If demand for O&P services at a satellite center increases beyond the ability of the O&P practitioner to service in one or two days a week, the company will staff the satellite office on a full-time basis. The Company estimates that the cost of opening a new patient-care center is approximately $100,000, which includes equipment, leasehold improvements and working capital. The Company expects a new patient-care center to reach profitability, as measured by EBITDA, within one year of opening. No assurance can be given that the Company will be successful in achieving these start-up and profitability goals with regard to new patient- care centers. PATIENT REIMBURSEMENT SOURCES The principal reimbursement sources for Hanger's O&P services are: (i) private payor/third-party insurer sources which consist of individuals, private insurance companies, HMOs, PPOs, hospitals, vocational rehabilitation, workers' compensation and similar sources; (ii) Medicare, which is a federally funded health insurance program providing coverage for persons aged 65 or older and certain disabled persons; (iii) Medicaid, which is a health insurance program jointly funded by federal and state governments providing coverage for certain persons in financial need, regardless of age, and which may supplement Medicare benefits for financially needy persons aged 65 or older; and (iv) the VA, with which Hanger has entered into contracts to provide O&P services. Medicare, Medicaid, the VA and certain state agencies, which accounted for approximately 56.8%, 62.0% and 52.0% of the Company's net sales in 1996, 1997 and the first quarter of 1998, respectively, (based on a sampling of approximately 75% of the patient-care centers in each period) have set maximum reimbursement levels for payments for O&P services and products. The health care policies and programs of these agencies 38 have been subject to changes in payment and methodologies during the past several years. There can be no assurance that future changes will not reduce reimbursements for O&P services and products from these sources. The Company provides O&P services to eligible veterans pursuant to several contracts with the VA. The VA establishes its reimbursement rates for itemized products and services on a competitive bidding basis. The Company's contracts with the VA expire in September 1998, with the option to renew for a one- or two-year period. The contracts, awarded on a non-exclusive basis, establish the amount of reimbursement to the eligible veteran if the veteran should choose to use the Company's products and services. The Company has been awarded VA contracts in the past and expects that it will obtain additional contracts when its present agreements expire. PATIENT-CARE CENTERS AND FACILITIES Hanger currently operates 240 patient-care centers, six distribution facilities and two manufacturing facilities, as detailed in the following table:
PATIENT-CARE DISTRIBUTION MANUFACTURING JURISDICTION CENTERS FACILITIES FACILITIES - ------------ -------------- -------------- ------------- Alabama............................. 14 - - Arizona............................. 4 - - California.......................... 4 1 - Colorado............................ 7 - - Connecticut......................... 12 - - Delaware............................ 1 - - District of Columbia................ 2 - - Florida............................. 32 1 1 Georgia............................. 20 1 - Illinois............................ - 1 1 Indiana............................. 2 - - Kentucky............................ 7 - - Louisiana........................... 8 - - Maryland............................ 6 1 - Massachusetts....................... 3 - - Michigan............................ 3 - - Mississippi......................... 7 - - Montana............................. 6 - - Nevada.............................. 1 - - New Hampshire....................... 1 - - New Mexico.......................... 1 - - New York............................ 8 - - North Carolina...................... 3 - - Ohio................................ 19 - - Pennsylvania........................ 24 - - South Carolina...................... 12 - - Tennessee........................... 10 - - Texas............................... 9 1 - Virginia............................ 6 - - West Virginia....................... 7 - - Wyoming............................. 1 - - ------- ------- ------- Total............................. 240 6 2 ======= ======= =======
39 COMPETITION The competition among O&P patient-care centers is primarily for referrals from physicians, therapists, employers, HMOs, PPOs, hospitals, rehabilitation centers, outpatient clinics and insurance companies on both a local and regional basis. The Company believes that distinguishing competitive factors in the O&P industry are quality and timeliness of patient care and, to a lesser degree, charges for services. While the Company believes it is one of the largest suppliers of O&P services in the United States, certain competitors may have greater financial and personnel resources than Hanger. The Company competes with others in the industry for trained personnel. To date, however, Hanger has been able to achieve its staffing needs and has experienced a relatively low turnover rate of employees. In connection with its efforts to acquire additional O&P patient-care practices, the Company encounters competition from several other O&P companies. GOVERNMENT REGULATION Certification and Licensure Most states do not require separate licensure for O&P practitioners. However, several states currently require O&P practitioners to be certified by an organization such as the ABC. The ABC conducts a certification program for practitioners and an accreditation program for patient-care centers. The minimum requirements for a certified practitioner are a college degree, completion of an accredited academic program, one to four years of residency at a patient-care center under the supervision of a certified practitioner and successful completion of certain examinations. Minimum requirements for an ABC-accredited patient-care center include the presence of a certified practitioner and specific plant and equipment requirements. While the Company endeavors to comply with all state licensure requirements, no assurance can be given that the Company will be in compliance at all times with these requirements. Hanger provides services under various contracts to federal agencies. These contracts are subject to regulations governing federal contracts, including the ability of the government to terminate for its convenience. Revenue from such contracts is not material to Hanger. Medical Device Regulation The Company manufactures and distributes products that are subject to regulation as medical devices by the Food and Drug Administration ("FDA") under the Federal Food, Drug, and Cosmetic Act and accompanying regulations. The Company believes that the products it manufactures and/or distributes, including O&P accessories and components, are exempt from FDA's regulations for premarket clearance or approval requirements and from requirements relating to "good manufacturing practices" (except for certain recordkeeping and complaint handling requirements). The Company is required to adhere to regulations regarding adverse event reporting, and is subject to inspection by the FDA for compliance with all applicable requirements. Labeling and promotional materials also are subject to scrutiny by the FDA and, in certain circumstances, by the Federal Trade Commission. Although the Company has never been challenged by FDA for noncompliance with FDA requirements, no assurance can be given that the Company would be found to be or to have been in compliance at all times. Noncompliance could result in a variety of civil and/or criminal enforcement actions, which could have a material adverse effect on the Company's financial condition and results of operations. Fraud and Abuse The Company is subject to various federal and state laws pertaining to health care fraud and abuse, including antikickback laws, false claims laws, and physician self-referral laws. Violations of these laws are punishable by criminal and/or civil sanctions, including, in some instances, imprisonment and exclusion from participation in federal health care programs, including Medicare, Medicaid, VA health programs and CHAMPUS. The Company has never been challenged by a governmental authority under any of these laws and believes that, based on this history, its operations are in material compliance with such laws. However, because 40 of the far-reaching nature of these laws, there can be no assurance that one or more of the Company's practices would not be required to alter its practices as a result, or that the occurrence of one or more of these events would not result in a material adverse effect on the Company's financial condition and results of operations. Antikickback Laws. The Company's operations are subject to federal and state antikickback laws. The Federal Health Care Programs Antikickback Statute (section 1128B(b) of the Social Security Act) prohibits persons or entities from knowingly and willfully soliciting, offering, receiving, or paying any remuneration in return for, or to induce, the referral of persons eligible for benefits under a Federal Health Care Program (including Medicare, Medicaid, the VA health programs and CHAMPUS), or the ordering, purchasing or leasing of items or services that may be paid for, in whole or in part, by a Federal Health Care Program. The statute may be violated when even one purpose (as opposed to a primary or sole purpose) of a payment is to induce referrals or other business. Regulations create a small number of "safe harbors." Practices which meet all the criteria of an applicable safe harbor will not be deemed to violate the statute; practices that do not satisfy all elements of a safe harbor do not necessarily violate the statute, although such practices may be subject to scrutiny by enforcement agencies. Several states also have antikickback laws which vary in scope and may apply regardless of whether a Federal Health Care Program is involved. These laws may apply to certain of the Company's operations. The Company has instituted various types of discount programs for individuals or entities that purchase its products and services. The Company also maintains financial relationships with individuals and entities who may: (i) purchase the Company's products and services; (ii) refer patients to Company-owned and managed O&P patient-care centers; or (iii) receive referrals through OPNET. These relationships include, among other things, lease arrangements with hospitals and OPNET participation arrangements. Because some of these arrangements may not satisfy all elements of an applicable safe harbor, they could be subject to scrutiny and challenge under one or more such laws. False Claims Laws. The Company is also subject to federal and state laws prohibiting individuals or entities from knowingly and willfully presenting, or causing to be presented, claims for payment to third-party payors (including Medicare and Medicaid) that are false or fraudulent or are for items or services not provided as claimed. Each Company-owned and managed O&P patient-care center is responsible for preparation and submission of reimbursement claims to third-party payors for items and services furnished to patients. In addition, Company personnel may, in some instances, provide advice on billing and reimbursement for the Company's products to purchasers. While the Company endeavors to ensure that its billing practices comply with applicable laws, if claims submitted to payors are deemed to be false, fraudulent, or for items or services not provided as claimed, the Company could face liability for presenting or causing to be presented such claims. Physician Self-Referral Laws. The Company is also subject to federal and state physician self-referral laws. With certain exceptions, the federal Medicare/Medicaid physician self-referral law (the "Stark" law, section 1877 of the Social Security Act) prohibits a physician from referring Medicare and Medicaid beneficiaries to an entity for "designated health services," including prosthetics, orthotics and prosthetic devices and supplies, if the physician has either an investment interest in the entity or a compensation arrangement with the entity. An exception is recognized for referrals made to a publicly-traded entity in which the physician has an investment interest if, among other things, the entity had stockholders' equity exceeding $75.0 million for its most recent fiscal year, or on average during the three previous fiscal years. Although the Company does not provide stock to referring physicians, the Company's stock is publicly-traded and the Company is not in a position to know or control whether some referring physicians may be investors. However, based upon the definition of stockholders' equity set forth in proposed regulations implementing the Stark law, the Company believes it has sufficient stockholders' equity to meet the exception that would allow physician-investors to refer Medicare and Medicaid beneficiaries to Company- owned and managed O&P patient-care centers in compliance with the Stark law. Antitrust The Company is subject to federal and state antitrust laws which prohibit, among other things, the establishment of ventures that result in certain anticompetitive conduct. These laws have been applied to the 41 establishment of certain networks of otherwise competing health care providers. In September 1995, the Antitrust Division of the Department of Justice ("DOJ") issued a business review letter which concluded, in part, that the description of OPNET voluntarily furnished to the DOJ by the Company "did not pose any significant competitive issues" and, therefore, DOJ "has no present intention of challenging [OPNET]" under federal antitrust law. Although the Company is not able to assure that the continued operation of OPNET will comply in all respects with the terms specified in the business review letter, noncompliance with these terms does not mean that the antitrust authorities or private parties would challenge the conduct, and the Company believes that the current operation of OPNET is not anticompetitive and results in significant efficiencies. However, DOJ reserves the right to bring an investigation or proceeding if it determines that OPNET is anticompetitive in purpose or effect. There can be no assurance that DOJ will not bring an investigation or proceeding challenging OPNET (or other aspects of the Company's operations) under these laws, or that such an investigation or proceeding would not result in a material adverse effect on the Company's financial condition and results of operations. PERSONNEL As of March 31, 1998, the Company employed 1,248 persons, including 1,168 full-time and 80 part-time employees. None of the Company's employees is subject to a collective bargaining agreement. The Company believes that it has satisfactory relationships with its employees and strives to maintain these relationships by offering competitive benefit packages, training programs and opportunities for advancement. INSURANCE The Company currently maintains insurance of the type and in the amount customary in the orthopedic rehabilitation industry, including coverage for malpractice liability, product liability, workers' compensation and property damage. Hanger's general liability insurance coverage is at least $500,000 per incident. Based on the Company's experience and prevailing industry practices, Hanger believes its coverage is adequate as to risks and amount. 42 MANAGEMENT EXECUTIVE OFFICERS, KEY EMPLOYEES AND DIRECTORS The following table sets forth information with respect to the executive officers and directors of the Company and certain key employees of subsidiaries of the Company:
NAME AGE POSITION - ---- --- -------- Ivan R. Sabel, CPO.................... 53 Chairman of the Board, President, Chief Executive Officer and Director Richard A. Stein...................... 38 Vice President--Finance, Secretary and Treasurer John D. McNeill, CPO.................. 50 President and Chief Operating Officer of Hanger Prosthetics & Orthotics, Inc. Alice G. Tidwell...................... 59 President and Chief Operating Officer of Southern Prosthetic Supply, Inc. Juan B. Paez.......................... 53 Vice President--Manufacturing of DOBI-Symplex, Inc. Jeffrey L. Martin..................... 44 Vice President of OPNET, Inc. Mitchell J. Blutt, M.D.(1)............ 41 Director Edmond E. Charrette, M.D.(2).......... 63 Director Thomas P. Cooper, M.D................. 54 Director Robert J. Glaser, M.D.(2)............. 79 Director James G. Hellmuth(1).................. 75 Director William L. McCulloch(2)............. 77 Director H.E. Thranhardt, CPO.................. 58 Director Risa J. Lavizzo-Maurey, M.D. ......... 43 Director
- -------- (1) Member of the Audit Committee. (2) Member of the Compensation Committee. Ivan R. Sabel has been Chairman of the Board of Directors and Chief Executive Officer of Hanger since August 1995 and President of Hanger since November 1987. Mr. Sabel also served as the Chief Operating Officer of Hanger from November 1987 until August 1995. Prior to that time, Mr. Sabel had been Vice President--Corporate Development from September 1986 to November 1987. From 1968 until joining Hanger in 1986, Mr. Sabel was the founder, owner and President of Capital Orthopedics, Inc. before that company was acquired by Hanger. Mr. Sabel is a Certified Prosthetist and Orthotist ("CPO"), a clinical instructor in orthopedics at the Georgetown University Medical School in Washington, D.C., a member of the Board of Directors of the American Orthotic and Prosthetic Association ("AOPA"), a former Chairman of the National Commission for Health Certifying Agencies, a former member of the Strategic Planning Committee and a current member of the Veterans Administration Affairs Committee of AOPA and a former President of the American Board for Certification in Orthotics and Prosthetics ("ABC"). Richard A. Stein has been Vice President--Finance, Secretary and Treasurer of Hanger since April 1987. Mr. Stein was also the President of Greiner & Saur Orthopedics, Inc., a former subsidiary of the Company, from April 1987 until November 1989. Mr. Stein is a Certified Public Accountant and was employed by Coopers & Lybrand L.L.P. from September 1982 until he joined Hanger in 1987. John D. McNeill, CPO has been the President and Chief Operating Officer of Hanger Prosthetics & Orthotics, Inc., a wholly-owned subsidiary of the Company that operates the Company's patient-care centers, since November 1, 1996. From 1990 to November 1, 1996, he was Senior Vice President, Chief Operating Officer and a director of JEH. From 1986 to 1990, Mr. McNeill was a Regional Vice President and an area manager for JEH. Mr. McNeill, who is a CPO, conducted his own O&P practice in Marietta, Georgia from 1979 to 1986, when it was acquired by JEH. 43 Alice G. Tidwell has been the President and Chief Operating Officer of Southern Prosthetic Supply, Inc., the Company's wholly-owned distribution subsidiary, since November 1, 1996. From 1990 to November 1, 1996, she served as a Senior Vice President and Chief Operating Officer of Southern Prosthetic Supply, Inc. From 1992 to 1996, Ms. Tidwell served on the Board of Directors of JEH. Previously, she served as supervisor, office manager and Vice President of Corporate Central Services of JEH. Juan B. Paez has been a Vice President of DOBI-Symplex, Inc., the Company's wholly-owned manufacturing subsidiary, since 1992. In addition to management responsibilities relating to the Company's manufacturing, central fabrication and distribution activities, Mr. Paez oversees new product and manufacturing business development. From 1990 to 1992, Mr. Paez was the Director of New Product Development of Bissell Healthcare and from 1982 to 1990 he was employed as Manager of Engineering and Research & Development and Manager of Industrial Engineering by Camp International. Jeffrey L. Martin has been the Vice President of OPNET, the Company's preferred provider network of O&P service professionals, since October 1995. In addition to being responsible for the recruitment of OPNET members and the planning and implementation of OPNET member services Mr. Martin directs the solicitation and management of OPNET managed care contracts. From 1984 until joining Hanger in 1995, Mr. Martin was Director of Marketing for the Ohio Willow Wood Company, a manufacturer of prosthetic componentry. Mitchell J. Blutt, M.D. has served as an Executive Partner of Chase Capital Partners (and its predecessor organizations), an affiliate of The Chase Manhattan Corporation (and its predecessor corporations), since June 1991. He joined that firm in July 1987 and became a General Partner in June 1988. Dr. Blutt also has been engaged in the practice of medicine for over five years. Previously, Dr. Blutt was a Robert Wood Johnson Foundation Fellow at the University of Pennsylvania School of Medicine and the Wharton School from July 1985 to June 1987. He is an adjunct Assistant Professor at the New York Hospital/Cornell Medical Center. Dr. Blutt is also a director of Urohealth Systems, Inc., a public company engaged in the manufacture, marketing and distribution of products used by urologists and gynecologists, Fisher Scientific Corporation, a public company engaged in the distribution of laboratory products, as well as numerous privately-held companies. Edmond E. Charrette, M.D. is the co-founder and Chairman of Health Resources Corporation (principally engaged in occupational medicine services). He also is a Partner of Ascendant Healthcare International (an investment group with equity investments in the Latin American health care sector) and serves as President of Latin Healthcare Investment Management Co., LLC (a group composed of Ascendant Healthcare International and The Global Environmental Fund which manages and directs the investment activities of the Latin Healthcare Investment Fund). Previously, he was the Executive Vice President and Chief Medical Officer of Advantage-Health Corporation (a multi-hospital rehabilitation and post-acute care system) from June 1994 to March 1996. From 1988 to May 1994, Dr. Charrette served as the Corporate Medical Director and Senior Vice President of Medical Affairs of Advantage Health Corporation. Thomas P. Cooper, M.D. has been employed as the President and Chief Executive Officer of Cove HealthCare, Inc., providing hospitalists and post- acute physicians to hospitals and long term care facilities, since January 1997. Dr. Cooper has also been employed as the President and Chief Executive Officer of Senior Psychology Services Management, Inc., which supplies psychologists to nursing home patients, since June 1991. From 1989 through 1997, he was the Chief Executive Officer of Mobilex U.S.A., a provider of portable diagnostic services to long term care facilities. Dr. Cooper was the founder of Spectrum Emergency Care, a provider of emergency room physicians to hospitals and clinics, and Correctional Medical Systems, a provider of health services to correctional facilities. Dr. Cooper has served as Director of Quality Assurance for ARA Living Centers, a company which operates long-term health care facilities, and as Medical Director for General Motors Corporation Assembly Division. He currently serves as a consultant to Chase Capital Partners and has served on the faculty of the University of California, San Diego Medical School. 44 Robert J. Glaser, M.D. was the Director for Medical Science and a Trustee of the Lucille P. Markey Charitable Trust, which provides major grants in support of basic biomedical research, from 1984 to June 1997, when the Trust ceased operations. He is a Consulting Professor of Medicine at Stanford University, where he served as the Dean of the School of Medicine from 1965 to 1970. Dr. Glaser was a founding member of the Institute of Medicine at the National Academy of Sciences and is a director of Alza Corporation (principally engaged in pharmaceutical research). He was a director of Hewlett-Packard Company from 1971 to 1991, and has continued to serve as a consultant to that company on health matters. James G. Hellmuth is a part-time consultant to Chase Capital Partners. He served as a director of BT Capital Corporation, an affiliate of Bankers Trust New York Corporation, from 1970 to 1997. He was a Commissioner of the Port Authority of New York and New Jersey from 1969 to 1997. In addition, Mr. Hellmuth was a Managing Director of Bankers Trust Company from 1972 to 1988. Brig. Gen. William L. McCulloch, USMC (Ret.) has served as the President of Association Communication and Marketing Services, a public relations firm, since October 1989. Previously, Gen. McCulloch was the Executive Director of AOPA, the trade association of the orthotic and prosthetic industry, from October 1976 to September 1989. In 1976, Gen. McCulloch retired from active military service after serving 30 years as a U.S. Marine infantry officer. H.E. Thranhardt, CPO is the former President and Chief Executive Officer of JEH. He served in that capacity from January 1, 1977 to November 1, 1996, on which date JEH was acquired by Hanger. Mr. Thranhardt, who commenced his employment with JEH in 1958, has occupied leadership positions in numerous professional O&P associations, including Chairman of the Board of the Orthotics and Prosthetics National Office in 1994 and 1995, President of the AOPA in 1992 and 1993, President of the ABC in 1979 and 1980 and President of The American Academy of Orthotics and Prosthetics in 1976 and 1977. Risa J. Lavizzo-Mourey, M.D., M.B.A., has been the Sylvan Eisman Professor of Medicine at the University of Pennsylvania School of Medicine since July 1997 and has served as the Director of the Institute on Aging at the University of Pennsylvania since December 1995. From February 1998 to present, Dr. Lavizzo-Mourey has served as a Member of the Institute of Medicine; from August 1996 to present, on the American Board of Internal Medicine; and from March 1995 to present, on the Board of Regents of the American College of Physicians. From March 1997 to March 1998, Dr. Lavizzo-Mourey also served as a Member of the United States Presidential Advisory Commission on Consumer Protection and Quality of Care in Health Care. From April 1992 to April 1994, Dr. Lavizzo-Mourey further served in each of the following positions: Chairperson of the Quality of Care Working Group White House Task Force on Health Care Reform; Deputy Administrator of the Agency on Health Care Policy and Research of the U.S. Department of Health and Human Services; and as a Member of the Senior Executive Service of the Public Health Service of the U.S. Department of Health and Human Services. Dr. Lavizzo-Mourey also currently serves on the Board of Directors of Kapson Senior Quarters Corp. (assisted living health care company), Beverly Enterprises, Inc. (long-term and sub-acute health care company), and Managed Care Solutions, Inc. (management services for long-term health care organizations). EMPLOYMENT AND NON-COMPETE AGREEMENTS Messrs. Sabel, Stein and McNeill and Ms. Tidwell have executed employment agreements with the Company which contain non-compete provisions. 45 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth certain information regarding the beneficial ownership of the Company's Common Stock as of May 31, 1998 and as adjusted to reflect the sale of the shares of Common Stock offered hereby (assuming no exercise of the Underwriters' over-allotment option), by: (i) each person known by Hanger to be the beneficial owner of 5% or more of the Company's outstanding Common Stock; (ii) each of Hanger's directors and executive officers; and (iii) all directors and executive officers of Hanger as a group.
SHARES BENEFICIALLY SHARES BENEFICIALLY SHARES BENEFICIALLY OWNED PRIOR TO NUMBER OWNED AFTER OWNED AFTER OFFERING(1) OF OFFERING(1) OFFERING PLUS ---------------------------SHARES ---------------------------SHARES UNDERLYING NAME NUMBER PERCENT OFFERED NUMBER PERCENT UNVESTED OPTIONS - ---- ------------ ----------------- ------------ ---------------------------- Chase Venture Capital Associates, L.P........ 2,426,689(2) 14.6% 800,000 1,626,689(2) 8.6% 1,626,689 Ivan R. Sabel, CPO...... 129,599(3) * 67,000 62,599(3) * 306,599 Mitchell J. Blutt, M.D.(4)................ -- -- -- -- -- -- Thomas P. Cooper, M.D... 24,250(5) * -- 24,250(5) * 36,750 Robert J. Glaser, M.D... 23,500(6) * -- 23,500(6) * 36,000 James G. Hellmuth....... 17,750(7) * -- 17,750(7) * 30,250 William L. McCulloch.... 25,000(8) * -- 25,000(8) * 37,500 Edmond E. Charrette, M.D.................... 33,750(9) * -- 33,750(9) * 45,000 H.E. Thranhardt, CPO.... 327,525(10) 2.1% -- 327,525(10) 1.8% 436,275 Risa J. Lavizzo-Mourey, M.D.................... 2,000(11) * -- 2,000(11) * 7,000 Richard A. Stein........ 68,190(12) * 33,000 35,190(12) * 156,190 All directors and executive officers as a group (10 persons) .. 651,564(13) 4.1% 100,000 551,564(13) 3.0% 1,091,564
- -------- * Represents less than 1%. (1) Assumes in the case of each stockholder listed above that all presently exercisable warrants or options held by such stockholder were fully exercised by such stockholder, without the exercise of any warrants or options held by any other stockholder. (2) Includes 830,649 shares subject to exercisable warrants to purchase shares from the Company. Reference is made to notes (4) and (5) below for information relating to two directors of the Company that are affiliated with CVCA. The address of CVCA and its sole general partner, Chase Capital Partners, is 380 Madison Avenue, New York, New York 10017. (3) Does not include 244,000 shares subject to unvested options that have not yet become exercisable and have a weighted average exercise price of $8.15 per share. (4) Does not include the shares reported above as owned by CVCA. Dr. Blutt is a General Partner of Chase Capital Partners, the sole general partner of CVCA. He disclaims beneficial ownership of the shares beneficially owned by CVCA. (5) Includes 17,750 shares subject to exercisable options to purchase shares from the Company and excludes 12,500 shares subject to unvested options that have not yet become exercisable. Dr. Cooper currently serves as a consultant to CVCA. (6) Includes 22,500 shares subject to exercisable options to purchase shares from the Company and excludes 12,500 shares subject to unvested options that have not yet become exercisable. (7) Includes 17,750 shares subject to exercisable options to purchase shares from the Company and excludes 12,500 shares subject to unvested options that have not yet become exercisable. (8) Includes 17,500 shares subject to exercisable options to purchase shares from the Company and excludes 12,500 shares subject to unvested options that have not yet become exercisable. (9) Includes 3,750 shares subject to an exercisable option to purchase shares from the Company and excludes 11,250 shares subject to unvested options that have not yet become exercisable. (10) Includes 184,027 shares owned directly by Mr. Thranhardt, 51,250 shares subject to exercisable options to purchase shares from the Company, 35,543 shares owned indirectly by him as trustee for members of his family, and 56,705 shares owned indirectly by him as a general partner of a family partnership; does not include 108,750 shares subject to unvested options that have not yet become exercisable. (11) Does not include 5,000 shares subject to unvested options that have not yet become exercisable. (12) Does not include 121,000 shares subject to unvested options that have not yet become exercisable and have a weighted average exercise price of $8.17 per share. (13) Includes 130,500 shares subject to exercisable options held by directors and executive officers of the Company to purchase shares from the Company and excludes 540,000 shares subject to unvested options held by such persons that have not yet become exercisable. The preceding table does not include 300 shares of the Company's non-voting Class C Preferred Stock, which constitutes all the outstanding shares of that class, held by the former stockholders of Scott Orthopedics, Inc., a company acquired by Hanger on February 13, 1990. 46 UNDERWRITING Subject to the terms and conditions of the Underwriting Agreement, the Underwriters named below (the "Underwriters"), through their Representatives, BT Alex. Brown Incorporated, NationsBanc Montgomery Securities LLC and Legg Mason Wood Walker, Incorporated, have severally agreed to purchase from the Company and the Selling Stockholders the following respective numbers of shares of Common Stock at the public offering price less the underwriting discounts and commissions set forth on the cover page of this Prospectus:
NUMBER OF UNDERWRITER SHARES - ----------- --------- BT Alex. Brown Incorporated........................................... NationBanc Montgomery Securities LLC.................................. Legg Mason Wood Walker, Incorporated.................................. --------- Total............................................................. 3,300,000 =========
The Underwriting Agreement provides that the obligations of the Underwriters are subject to certain conditions precedent and that the Underwriters will purchase all shares of Common Stock offered hereby if any such shares are purchased. The Company and the Selling Stockholders have been advised by the Representatives of the Underwriters that the Underwriters propose to offer the shares of Common Stock to the public at the public offering price set forth on the cover page of this Prospectus and to certain dealers at such price less a concession not in excess of $ per share. The Underwriters may allow, and such dealers may reallow, a concession not in excess of $ per share to certain other dealers. After commencement of the offering, the offering price and other selling terms may be changed by the Representatives of the Underwriters. The Company has granted to the Underwriters an option, exercisable not later than 30 days after the date of this Prospectus, to purchase up to 495,000 additional shares of Common Stock at the public offering price less the underwriting discounts and commissions set forth on the cover page of this Prospectus. To the extent that the Underwriters exercise such option, each of the Underwriters will have a firm commitment to purchase approximately the same percentage thereof that the number of shares of Common Stock to be purchased by each of them as shown in the above table bears to 3,300,000, and the Company will be obligated, pursuant to such option, to sell such shares to the Underwriters. The Underwriters may exercise such option only to cover over-allotments made in connection with the sale of the Common Stock offered hereby. If purchased, the Underwriters will offer such additional shares on the same terms as those on which the 3,300,000 shares are being offered. In connection with the offering of the Common Stock, the Underwriters may engage in transactions that stabilize, maintain or otherwise affect the market price of the Common Stock. Specifically, the Underwriters may over-allot shares of the Common Stock in connection with the offering, thereby creating a short position in the Underwriters' account. Additionally, to cover such short position or to stabilize the market price of the Common Stock, the Underwriters may bid for, and purchase, shares of the Common Stock at a level above that which might otherwise prevail in the open market. The Underwriters are not required to engage in these activities, and, if commenced, any such activities may be discontinued at any time. These activities may be effected on the American Stock Exchange, in the over-the-counter market or otherwise. The Underwriters also may impose a penalty bid whereby they may reclaim selling concessions allowed to an Underwriter or dealer, if the Underwriters repurchase, in stabilizing or covering transactions, shares distributed by that Underwriter or dealer. The Underwriting Agreement contains covenants of indemnity and contribution between the Underwriters and the Company and the Selling Stockholders with respect to certain civil liabilities, including liabilities under the Securities Act. 47 The Company and its executive officers and directors and certain stockholders owning an aggregate of 2,117,104 shares of Common Stock and options and warrants to purchase 1,321,149 shares have agreed that they will not offer, sell or otherwise dispose of any shares of Common Stock for a period of 90 days after the date of this Prospectus without the prior written consent of BT Alex. Brown Incorporated on behalf of the Underwriters. LEGAL MATTERS The validity of the shares of Common Stock offered hereby is being passed upon for the Company by Freedman, Levy, Kroll & Simonds, Washington, D.C. Certain legal matters relating to the sale of the Common Stock offered hereby will be passed upon for the Underwriters by Hogan & Hartson L.L.P., Baltimore, Maryland. EXPERTS The consolidated balance sheets of the Company as of December 31, 1996 and 1997, and the consolidated statements of income, changes in shareholders' equity and cash flows of the Company for each of the three years in the period ended December 31, 1997, have been included herein and incorporated herein by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1997 in reliance upon the report of Coopers & Lybrand L.L.P. independent accountants, given on the authority of that firm as experts in accounting and auditing. 48 AVAILABLE INFORMATION The Company is subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance therewith, files reports and other information with the Securities and Exchange Commission (the "Commission"). Reports, proxy and information statements filed by the Company with the Commission pursuant to the informational requirements of the Exchange Act may be inspected and copied, at prescribed rates, at the public reference facilities maintained by the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the Regional Offices of the Commission: Northeast Regional Office, 7 World Trade Center, Suite 1300, New York, New York 10048; and Midwest Regional Office, Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. The Commission also maintains a World Wide Web site that contains reports, proxy and information statements regarding registrants, including the Company, that file such information electronically with the Commission. The address of the Commission's Web site is (http://www.sec.gov). In addition, reports, proxy statements and other information concerning the Company can be inspected at the offices of the American Stock Exchange, 86 Trinity Place, New York, New York 10006, on which the Common Stock of the Company is listed. The Company has filed with the Commission a Registration Statement on Form S-3 (herein, together with all amendments and exhibits, referred to as the "Registration Statement") under the Securities Act of 1933, as amended (the "Securities Act"). This Prospectus does not contain all of the information set forth in the Registration Statement, certain parts of which are omitted in accordance with the rules and regulations of the Commission. For further information, reference is hereby made to the Registration Statement. DOCUMENTS INCORPORATED BY REFERENCE The following documents filed by the Company with the Commission (File No. 1-10670) pursuant to Section 13 of the Exchange Act are hereby incorporated by reference in this Prospectus: 1. Annual Report on Form 10-K for the fiscal year ended December 31, 1997, as amended. 2. Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. 3. Description of the Common Stock contained in the Company's Registration Statement on Form 8-A filed on December 14, 1990. All documents filed by the Company with the Commission pursuant to Section 13(a) of the Exchange Act and any definitive proxy statement so filed pursuant to Section 14 of the Exchange Act and any reports filed pursuant to Section 15(d) of the Exchange Act after the date of the initial registration statement and prior to the effectiveness of the registration statement, and after the date of this Prospectus and prior to the termination of the offering shall be deemed to be incorporated by reference into this Prospectus and to be a part hereof from the date of filing of such documents. Any statement contained herein or in any document incorporated by reference herein will be deemed to be modified or superseded for purposes of this Prospectus to the extent any statement contained in this Prospectus modifies or supersedes such statement. Any such statements so modified or superseded will not be deemed, except as so modified or superseded, to constitute a part of this Prospectus. The Company will provide without charge to each person to whom a copy of this Prospectus is delivered, upon the written or oral request of any such person, a copy of the documents described above (other than exhibits). Requests for such copy should be directed to Hanger Orthopedic Group, Inc., 7700 Old Georgetown Road, Bethesda, Maryland 20814, Attention: Mr. Richard A. Stein, Secretary, telephone (301) 986-0701. 49 INDEX TO FINANCIAL STATEMENTS Report of Independent Accountants........................................ F-2 Consolidated balance sheets as of December 31, 1996 and 1997 and March 31, 1998 (unaudited).................................................... F-3 Consolidated statements of income for the years ended December 31, 1995, 1996 and 1997 and the quarters ended March 31, 1997 and 1998 (unaudited)............................................................. F-4 Consolidated statements of changes in shareholders' equity for the years ended December 31, 1995, 1996 and 1997 and the quarter ended March 31, 1998 (unaudited)........................................................ F-5 Consolidated statements of cash flow for the years ended December 31, 1995, 1996 and 1997 and the quarters ended March 31, 1997 and 1998 (unaudited)............................................................. F-6 Notes to Consolidated Financial Statements............................... F-7
F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Hanger Orthopedic Group, Inc. We have audited the accompanying consolidated balance sheets of Hanger Orthopedic Group, Inc. and Subsidiaries as of December 31, 1996 and 1997 and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hanger Orthopedic Group, Inc., and Subsidiaries as of December 31, 1996 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Coopers & Lybrand L.L.P. 2400 Eleven Penn Center Philadelphia, Pennsylvania March 13, 1998 F-2 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED BALANCE SHEETS
DECEMBER 31, -------------------------- MARCH 31, 1996 1997 1998 ------------ ------------ ------------ (UNAUDITED) ASSETS Current assets Cash and cash equivalents....... $ 6,572,402 $ 6,557,409 $ 5,652,746 Accounts receivable, less allowances for doubtful accounts of $2,478,800, $4,871,000 and $6,266,000 in 1996, 1997 and 1998, respectively................... 24,321,872 31,145,327 31,655,712 Inventories..................... 15,916,638 17,445,476 17,633,551 Prepaid and other assets........ 1,595,169 4,260,656 4,028,619 Deferred income taxes........... 3,159,280 2,127,185 2,127,185 ------------ ------------ ------------ Total current assets............ 51,565,361 61,536,053 61,097,813 ------------ ------------ ------------ Property, plant and equipment Land............................ 4,269,045 4,269,045 4,267,045 Buildings....................... 8,017,547 8,326,732 8,342,849 Machinery and equipment......... 6,275,307 7,591,821 8,295,019 Furniture and fixtures.......... 2,095,900 2,378,808 2,465,199 Leasehold improvements.......... 2,139,207 3,142,244 3,495,718 ------------ ------------ ------------ 22,797,006 25,708,650 26,865,830 Less accumulated depreciation and amortization............... 5,497,809 7,538,385 8,134,225 ------------ ------------ ------------ 17,299,197 18,170,265 18,731,605 ------------ ------------ ------------ Intangible assets Excess cost over net assets acquired....................... 63,935,447 81,150,328 92,853,728 Non-compete agreements.......... 1,981,329 2,236,979 2,295,265 Other intangible assets......... 6,152,607 3,221,912 3,230,052 ------------ ------------ ------------ 72,069,383 86,609,219 98,379,045 Less accumulated amortization... 6,917,960 9,101,531 9,765,256 ------------ ------------ ------------ 65,151,423 77,507,688 88,613,789 Other assets Other........................... 925,446 768,604 964,205 ------------ ------------ ------------ Total assets.................... $134,941,427 $157,982,610 $169,407,412 ============ ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Current portion of long-term debt........................... $ 4,902,572 $ 5,747,865 $ 10,310,984 Accounts payable................ 4,141,993 3,827,338 3,712,060 Accrued expenses................ 7,815,028 3,597,104 4,465,388 Customer deposits............... 578,219 1,145,001 1,130,483 Accrued compensation related cost........................... 8,321,395 8,037,805 5,313,447 Deferred revenue................ 306,998 150,418 309,801 ------------ ------------ ------------ Total current liabilities....... 26,066,205 22,505,531 25,242,163 ------------ ------------ ------------ Long-term debt................... 64,297,801 23,237,321 29,286,054 Deferred income taxes............ 2,377,627 3,405,833 3,405,833 Other liabilities................ 2,188,278 2,210,445 2,236,007 Mandatorily redeemable preferred stock class C, 300 shares authorized, liquidation preference of $500 per share (See Note M).................... 277,701 303,753 310,588 Mandatorily redeemable preferred stock class F, 100,000 shares authorized, liquidation preference of $1,000 per share (See Note M).................... Commitments and contingent liabilities..................... Shareholders' equity Common stock, $0.01 par value; 25,000,000 shares authorized, 9,449,129, 15,670,100 and 15,778,996 shares issued and 9,315,634, 15,536,605 and 15,645,501 shares outstanding in 1996, 1997 and 1998, respectively................... 94,492 156,702 157,791 Additional paid-in capital...... 41,008,363 102,585,837 103,496,362 Retained earnings (accumulated deficit)....................... (713,478) 4,232,750 5,928,176 ------------ ------------ ------------ 40,389,377 106,975,289 109,582,329 Treasury stock, cost--(133,495 shares)........................ (655,562) (655,562) (655,562) ------------ ------------ ------------ 39,733,815 106,319,727 108,926,767 ------------ ------------ ------------ Total liabilities and shareholders' equity........... $134,941,427 $157,982,610 $169,407,412 ============ ============ ============
The accompanying notes are an integral part of the consolidated financial statements. F-3 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, QUARTERS ENDED MARCH 31, -------------------------------------- -------------------------- 1995 1996 1997 1997 1998 ----------- ----------- ------------ ------------ ------------ (UNAUDITED) Net sales............... $52,467,899 $66,805,944 $145,597,876 $ 30,949,614 $ 40,750,018 Cost of products and services sold.......... 24,572,089 32,233,373 73,533,398 16,229,929 21,303,131 ----------- ----------- ------------ ------------ ------------ Gross profit............ 27,895,810 34,572,571 72,064,478 14,719,685 19,446,887 Selling, general and administrative......... 19,361,701 24,549,802 49,075,956 10,924,635 14,729,001 Depreciation and amortization........... 2,005,113 2,016,390 2,870,539 749,305 709,022 Amortization of excess cost over net assets acquired............... 686,275 832,075 1,810,283 409,512 550,961 Acquisition costs....... 1,297,819 Integration costs....... 1,181,694 ----------- ----------- ------------ ------------ ------------ Income from operations.. 5,842,721 4,694,791 18,307,700 2,636,233 3,457,903 Interest expense........ (2,056,140) (2,546,561) (4,932,385) (1,527,269) (614,822) Other expense, net...... (106,644) (177,216) (209,296) (43,749) 30,345 ----------- ----------- ------------ ------------ ------------ Income before taxes and extraordinary item..... 3,679,937 1,971,014 13,166,019 1,065,215 2,873,426 Provision for income taxes.................. 1,544,498 889,886 5,526,000 447,300 1,178,000 ----------- ----------- ------------ ------------ ------------ Income before extraordinary item..... 2,135,439 1,081,128 7,640,019 617,915 1,695,426 Extraordinary loss on early extinguishment of debt, net of tax benefit................ (83,234) (2,693,791) ----------- ----------- ------------ ------------ ------------ Net income.............. $ 2,135,439 $ 997,894 $ 4,946,228 $ 617,915 $ 1,695,426 =========== =========== ============ ============ ============ Income before extraordinary item applicable to common stock.................. $ 2,113,640 $ 1,057,313 $ 7,613,967 $ 611,620 $ 1,688,591 =========== =========== ============ ============ ============ Basic Per Common Share Data: Income before extraordinary item..... $ 0.25 $ 0.12 $ 0.65 $ 0.07 $ 0.11 ----------- ----------- ------------ ------------ ------------ Extraordinary item, net of tax benefit......... (0.01) (0.23) ----------- ----------- ------------ ------------ ------------ Net income.............. $ 0.25 $ 0.11 $ 0.42 $ 0.07 $ 0.11 =========== =========== ============ ============ ============ Shares used to compute basic per common share amounts................ 8,290,544 8,469,645 11,792,892 9,358,529 15,576,030 Diluted Per Common Share Data: Income before extraordinary item..... $ 0.25 $ 0.12 $ 0.58 $ 0.06 $ 0.10 Extraordinary item, net of tax benefit......... (0.01) (0.21) ----------- ----------- ------------ ------------ ------------ Net income.............. $ 0.25 $ 0.11 $ 0.37 $ 0.06 $ 0.10 =========== =========== ============ ============ ============ Shares used to compute diluted per common share amounts.......... 8,299,516 8,663,161 13,138,377 9,940,659 17,081,983
The accompanying notes are an integral part of the consolidated financial statements. F-4 HANGER ORTHOPEDIC GROUP, INC CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 AND THE QUARTER ENDED MARCH 31, 1998 (UNAUDITED)
RETAINED ADDITIONAL EARNINGS COMMON COMMON PAID-IN (ACCUMULATED TREASURY SHARES STOCK CAPITAL DEFICIT) STOCK TOTAL ---------- -------- ------------ ------------ --------- ------------ Balance, December 31, 1994................... 8,290,544 $ 84,241 $ 33,595,857 $(3,846,811) $(655,562) $ 29,177,725 Preferred dividends declared............... (21,799) (21,799) Net Income.............. 2,135,439 2,135,439 ---------- -------- ------------ ----------- --------- ------------ Balance, December 31, 1995................... 8,290,544 84,241 33,574,058 (1,711,372) (655,562) 31,291,365 ---------- -------- ------------ ----------- --------- ------------ Preferred dividends declared............... (23,815) (23,815) Net Income.............. 997,894 997,894 Issuance of Common Stock in connection with the exercise of stock options................ 13,758 138 46,733 46,871 Issuance of Common Stock in connection with the exercise of stock warrants............... 11,332 113 (113) Issuance of Common Stock in connection with the purchase of JEH........ 1,000,000 10,000 5,240,000 5,250,000 Issuance of Warrants in connection with the purchase of JEH........ 133,000 133,000 Issuance of Warrants in connection with the Senior Subordinated Note Agreement......... 2,038,500 2,038,500 ---------- -------- ------------ ----------- --------- ------------ Balance, December 31, 1996................... 9,315,634 94,492 41,008,363 (713,478) (655,562) 39,733,815 ---------- -------- ------------ ----------- --------- ------------ Preferred dividends declared............... (26,052) (26,052) Net Income.............. 4,946,228 4,946,228 Issuance of Common Stock in connection with the exercise of stock options................ 395,277 3,953 2,823,194 2,827,147 Issuance of Common Stock in connection with the exercise of stock warrants............... 11,694 117 (117) Issuance of Common Stock in connection with the purchase of Fort Walton Mobile................. 64,000 640 499,360 500,000 Issuance of Common Stock in Public Offering..... 5,750,000 57,500 58,281,089 58,338,589 ---------- -------- ------------ ----------- --------- ------------ Balance, December 31, 1997................... 15,536,605 156,702 102,585,837 4,232,750 (655,562) 106,319,727 ---------- -------- ------------ ----------- --------- ------------ Preferred dividends declared............... (6,835) (6,835) Net Income.............. 1,695,426 1,695,426 Issuance of Common Stock in connection with the exercise of stock options................ 108,896 1,089 917,360 918,449 ---------- -------- ------------ ----------- --------- ------------ Balance, March 31, 1998................... 15,645,501 $157,791 $103,496,362 $5,928,176 $(655,562) $108,926,767 ========== ======== ============ =========== ========= ============
The accompanying notes are an integral part of the consolidated financial statements. F-5 HANGER ORTHOPEDIC GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOW
YEARS ENDED DECEMBER 31, QUARTERS ENDED MARCH 31, ------------------------------------ ----------------------- 1995 1996 1997 1997 1998 ---------- ----------- ----------- ---------- ----------- (UNAUDITED) Cash flow from operating activities: Net income............. $2,135,439 $ 997,894 $ 4,946,228 $ 617,915 $ 1,695,426 Adjustments to reconcile net income to net cash provided by (used in) operations: Provision for bad debt................. 1,008,731 1,629,065 5,613,076 999,208 1,702,241 Provision for inventory reserves... 1,160,000 Depreciation and amortization......... 2,005,113 2,016,390 2,870,539 749,305 709,022 Amortization of excess cost over net assets acquired............. 686,275 832,075 1,810,283 409,512 550,961 Amortization of debt discount............. 42,469 152,065 318,515 Deferred taxes........ 631,899 (684,119) 2,060,301 Extraordinary loss on early extinguishment of debt.............. 138,724 4,644,491 Changes in assets and liabilities, net of effects from acquired companies: Accounts receivable......... (1,922,572) (2,772,619) (9,380,532) (1,145,684) (272,575) Inventories......... (800,933) 737,104 (1,068,769) 274,166 236,234 Prepaid and other assets............. 108,112 (199,638) (2,586,738) (1,161,495) 362,852 Other assets........ 151,367 27,342 176,083 (49,638) (203,723) Accounts payable.... 48,462 361,441 (1,326,067) (1,314,988) (624,949) Accrued expenses.... (618,105) 709,638 (1,000,414) 1,407,612 848,880 Accrued wages & payroll taxes...... 72,272 1,942,581 (400,575) (3,433,979) (3,221,776) Customer deposits... 97,036 88,461 576,240 127,954 (14,294) Deferred revenue.... 82,897 126,411 (156,580) (20,486) (38,507) Other liabilities... 35,628 (66,459) 22,167 72,577 25,562 ---------- ----------- ----------- ---------- ----------- Net cash provided by (used in) operating ac- tivities............... 3,721,621 5,926,760 8,111,798 (2,149,506) 1,755,354 ---------- ----------- ----------- ---------- ----------- Cash flow from investing activities: Purchase of fixed assets............... (934,798) (1,239,364) (2,581,424) (495,970) (605,905) Acquisitions, net of cash................. (273,939) (37,671,754) (15,800,077) (2,301,618) (10,713,583) Purchase of patent.... (70,552) (31,840) (88,671) (40,009) (8,140) Purchase of non- compete agreements... (35,000) (200,000) (255,650) (50,000) (58,286) Decrease in other intangibles.......... (24,321) (7,596) ---------- ----------- ----------- ---------- ----------- Net cash used in invest- ing activities......... (1,338,610) (39,150,554) (18,725,822) (2,887,597) (11,385,914) ---------- ----------- ----------- ---------- ----------- Cash flow from financing activities: Net borrowings (repayments) under revolving credit agreement............ (100,000) (12,700,000) 500,000 4,000,000 Proceeds from the sale of Common Stock...... 46,871 61,165,736 85,400 918,449 Proceeds from long- term debt............ 65,000,000 8,256,000 5,500,000 5,000,000 Repayment of debt..... (1,882,706) (11,040,029) (58,781,418) (900,678) (1,192,552) (Increase) decrease in financing costs...... 7,619 (2,966,951) (41,287) ---------- ----------- ----------- ---------- ----------- Net cash provided by (used in) financing ac- tivities............... (1,975,087) 38,339,891 10,599,031 5,184,722 8,725,897 ---------- ----------- ----------- ---------- ----------- Increase (decrease) in cash and cash equiva- lents.................. 407,924 5,116,097 (14,993) 147,619 (904,663) Cash and cash equiva- lents at beginning of period................. 1,048,381 1,456,305 6,572,402 6,572,402 6,557,409 ---------- ----------- ----------- ---------- ----------- Cash and cash equiva- lents at end of peri- od..................... $1,456,305 $ 6,572,402 $ 6,557,409 $6,720,021 $ 5,652,746 ========== =========== =========== ========== ===========
The accompanying notes are an integral part of the consolidated financial statements. F-6 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A--THE COMPANY Hanger Orthopedic Group, Inc. is one of the nation's largest professional practice management companies in the O&P rehabilitation industry. In addition to providing O&P patient-care services through its operating subsidiaries, the Company also manufactures and distributes components and finished patient-care products to the O&P industry primarily in the United States. Hanger's largest subsidiary, Hanger Prosthetics & Orthotics, Inc. formerly known as J.E. Hanger, Inc., was founded in 1861 by a Civil War amputee and is the oldest company in the O&P industry in the United States. Orthotics is the design, fabrication, fitting and supervised use of custom-made braces and other devices that provide external support to treat musculoskeletal disorders. Prosthetics is the design, fabrication and fitting of custom-made artificial limbs. NOTE B--SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents: Cash includes currency on hand and demand deposits with high quality financial institutions. Management considers all highly liquid investments with original maturities of three months or less at the date of purchase to be cash equivalents. At various times throughout the year, the Company maintains cash balances in excess of FDIC limits. Fair Value of Financial Instruments: At December 31, 1996 and 1997, the carrying value of financial instruments such as cash and cash equivalents, trade receivables, trade payables, and debt approximates fair value. Inventories: Inventories, which consist principally of purchased parts, are stated at the lower of cost or market using the first-in, first-out (FIFO) method. Long-Lived Asset Impairment: The Company reviews its long-lived assets for impairment on an exception basis whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through future cash flows. If it is determined that an impairment loss has occurred based on expected cash flows, then the loss is recognized in the income statement. Property, Plant and Equipment: Property, plant and equipment are recorded at cost. The cost and related accumulated depreciation of assets sold, retired or otherwise disposed of are removed from the respective accounts, and any resulting gains or losses are included in the statement of income. Depreciation is computed for financial reporting purposes using the straight- line method over the estimated useful lives of the related assets ranging from 5 to 20 years. Depreciation expense was approximately $1,136,000, $1,288,000 and $2,173,000 for the years ended December 31, 1995, 1996 and 1997, respectively and $530,000 and $596,000 for the quarters ended March 31, 1997 and 1998, respectively. Intangible Assets: Intangible assets, including non-compete agreements, are recorded based on agreements entered into by the Company and are being amortized over their estimated useful lives ranging from 5 to 7 years F-7 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) using the straight-line method. Other intangible assets are recorded at cost and are being amortized over their estimated useful lives of up to 16 years using the straight-line method. Excess cost over net assets acquired represents the excess of purchase price over the value assigned to net identifiable assets of purchased businesses and is being amortized using the straight-line method over 40 years. Fully amortized intangible assets amounting to approximately $3,225,000 were removed from the financial statements at December 31, 1996. Revenue Recognition: Revenue on the sale of orthotic and prosthetic devices is recorded when the device is accepted by the patient. Revenues from referral service contracts is recognized over the term of the contract. Deferred revenue represents billings made prior to the final fitting and acceptance by the patient and unearned service contract revenue. Revenue is recorded at its net realizable value taking into consideration all governmental and contractual discounts. Credit Risk: The Company primarily provides services and customized devices throughout the United States and is reimbursed by the patients' third-party insurers or governmentally funded health insurance programs. The Company performs ongoing credit evaluations of its distribution customers. The accounts receivable are not collateralized. The ability of the Company's debtors to meet their obligations is dependent upon the financial stability of the insurers of the Company's customers and future legislation and regulatory actions. Additionally, the Company maintains reserves for potential losses from these receivables that historically have been within management's expectations. Income Taxes: Income taxes are determined in accordance with Statement of Financial Accounting Standards ("SFAS") 109, which requires recognition of deferred income tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income tax liabilities and assets are determined based on the difference between financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. SFAS 109 also provides for the recognition of deferred tax assets if it is more likely than not that the assets will be realized in future years. Stock-Based Compensation: Compensation costs attributable to stock option and similar plans are recognized based on any difference between the quoted market price of the stock on the date of the grant over the amount the employee is required to pay to acquire the stock (the intrinsic value method under Accounting Principles Board Opinion 25). SFAS 123, "Accounting for Stock-Based Compensation," requires companies electing to continue to use the intrinsic value method to make pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied. The Company has adopted the disclosure only provisions of SFAS 123. New Accounting Standards: Effective January 1, 1998 the Company adopted the provisions of SFAS 130, "Reporting Comprehensive Income." SFAS 130 establishes standards for reporting and display of comprehensive income and its components in the financial statements. Reclassification of financial statements for earlier periods provided for comparative purposes is required. The adoption of SFAS 130 had no effect on the Company's consolidated financial statements. The Company will adopt the provisions of SFAS 131, "Disclosures about Segments of an Enterprise and Related Information" effective with the financial statements for the year ended December 31, 1998. SFAS 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. Financial statement disclosures for prior periods are required to be restated. The Company is in the process of evaluating the disclosure requirements. The adoption of SFAS 131 affects disclosure only and will not affect reported earnings, cash flows or financial position. F-8 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Interim Financial Information: The accompanying unaudited consolidated interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the quarter ended March 31, 1998 are not necessarily indicative of the results that may be expected for the year ending December 31, 1998. Reclassifications: Certain previously reported amounts have been reclassified to conform with the current year presentation. NOTE C--SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION The following are the supplemental disclosure requirements for the statements of cash flows:
YEARS ENDED QUARTERS ENDED DECEMBER 31, MARCH 31, -------------------------------- ------------------ 1995 1996 1997 1997 1998 ---------- ---------- ---------- -------- --------- (UNAUDITED) Cash paid during the period for: Interest................. $2,166,877 $2,273,629 $5,361,176 $641,926 $ 483,646 Income taxes............. 712,800 1,893,990 2,469,000 99,240 325,400 Non-cash financing and in- vesting activities: Preferred dividends de- clared.................... 21,799 23,815 26,052 6,295 6,835 Issuance of notes in connection with acquisition............... 175,000 8,314,200 250,000 2,755,000 Issuance of Common Stock in connection with acquisition............... 5,250,000 500,000 Issuance of warrants in connection with acquisition............... 133,000 Issuance of warrants in connection with Senior Subordinated Notes........ 2,038,500 Issuance of Common Stock in connection with exercise of warrants/options....... 113 117 Change in goodwill resulting from reduction in estimated acquisition costs..................... 3,236,552
NOTE D--ACQUISITIONS During 1996, the Company acquired one orthotic and prosthetic company, J.E. Hanger, Inc. of Georgia ("JEH"), pursuant to the terms of a Merger Agreement. As of the acquisition date, JEH, headquartered in Alpharetta, Georgia, operated 94 patient-care centers and five warehouses located primarily in the Mid-Atlantic and Southeastern United States. Under the terms of the agreement, which became effective on November 1, 1996, the Company paid JEH shareholders $44.0 million in cash and issued 1.0 million shares of Company Common Stock and paid an additional $1,783,000 to the former JEH shareholders on March 27, 1997 pursuant to provisions in the Merger Agreement calling for a post-closing adjustment. In addition the Company issued 35,000 warrants to one JEH noteholder in order to facilitate assumption of this debt under the same terms and conditions that had existed prior to the acquisition. F-9 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) During 1997, the Company acquired nine orthotic and prosthetic companies and the remaining 20% interest of its majority owned subsidiary, Columbia Brace. The aggregate purchase price, excluding potential earn-out provisions was $22,529,200 comprised of $13,715,000 in cash, $8,314,200 in promissory notes and 64,000 shares of Common Stock of the Company valued at $500,000. The notes are payable over two to five years with interest rates ranging from 6% to 8%. The cash portion of these acquisitions was borrowed under the Company's acquisition loan facility. All of the above acquisitions have been accounted for as business combinations in accordance with the purchase method. The results of operations for these acquisitions are included in the Company's results of operations from their date of acquisition. Excess cost over net assets acquired in these acquisitions amounting to approximately $36,699,000 and $20,451,000 in 1996 and 1997, respectively, are amortized using the straight-line method over 40 years. The following table summarizes the unaudited consolidated pro forma information, assuming the acquisitions had occurred at the beginning of each of the following periods:
1996 1997 ------------ ------------ Net sales........................................ $141,010,000 $156,946,000 Income before extraordinary item................. 1,546,000 7,772,000 Net income....................................... 1,463,000 5,078,000 Diluted income per common share before extraordi- nary item....................................... $0.15 $0.59 Diluted income per common share.................. $0.15 $0.38
The pro forma results do not necessarily represent results which would have occurred if the acquisitions had taken place at the beginning of each period, nor are they indicative of the results of future combined operations. During the first quarter ended March 31, 1998, the Company acquired three orthotic and prosthetic companies. The aggregate purchase price was $13,230,000, comprised of $10,475,000 in cash and $2,755,000 in promissory notes. Excess cost over net assets acquired amounted to approximately $11,200,000 in connection with these acquisitions. The Company borrowed $4,000,000 under the Revolving Loan Commitment and $5,000,000 under the Acquisition Loan Commitment to finance the cash portion of the purchase price. F-10 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE E--NET INCOME PER COMMON SHARE Basic per common share amounts are computed using the weighted average number of common shares outstanding during the year. Diluted per common share amounts are computed using the weighted average number of common shares outstanding during the year and dilutive potential common shares. Dilutive potential common shares consist of stock options and stock warrants and are calculated using the treasury stock method. Earnings per share amounts have been restated in accordance with SFAS 128, "Earnings Per Share." This restatement did not result in a material change between diluted per share amounts and amounts previously reported. Earnings per share are computed as follows:
YEARS ENDED DECEMBER 31, QUARTERS ENDED MARCH 31, ---------------------------------- -------------------------- 1995 1996 1997 1997 1998 ---------- ---------- ---------- ------------ ------------ (UNAUDITED) (UNAUDITED) Income before extraordinary item..... $2,135,439 $1,081,128 $7,640,019 $ 617,915 $ 1,695,426 Less preferred stock dividends declared..... (21,799) (23,815) (26,052) (6,295) (6,835) ---------- ---------- ---------- ----------- ------------ Income available to common stockholders.... $2,113,640 $1,057,313 $7,613,967 $ 611,620 $ 1,688,591 ========== ========== ========== =========== ============ Average shares of common stock outstanding used to compute basic per common share amounts... 8,290,544 8,469,645 11,792,892 9,358,529 15,576,030 Effect of dilutive options................ 8,972 163,442 556,476 193,849 1,049,473 Effect of dilutive warrants............... 30,074 789,009 388,281 456,480 ---------- ---------- ---------- ----------- ------------ Shares used to compute dilutive per common share amounts.......... 8,299,516 8,663,161 13,138,377 9,940,659 17,081,983 ========== ========== ========== =========== ============ Basic income per common share before extraordinary item..... $0.25 $0.12 $0.65 $0.07 $0.11 Diluted income per common share before extraordinary item..... $0.25 $0.12 $0.58 $0.06 $0.10
Options to purchase 528,750 shares of common stock at prices ranging from $11.31 per share to $13.25 per share were outstanding at December 31, 1997 but were not included in the computation of diluted income per common share because the options' exercise price was greater than the average market price of the common shares. NOTE F--INVENTORY Inventories at December 31, 1996 and 1997 and March 31, 1998 consist of the following:
DECEMBER 31, ----------------------- MARCH 31, 1996 1997 1998 ----------- ----------- ----------- (UNAUDITED) Raw materials............................ $ 7,504,442 $ 7,685,134 $ 7,858,656 Work in-process.......................... 831,632 1,437,946 1,467,133 Finished goods........................... 7,580,564 8,322,396 8,307,762 ----------- ----------- ----------- $15,916,638 $17,445,476 $17,633,551 =========== =========== ===========
F-11 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE G--LONG-TERM DEBT Long-term debt consists of the following at December 31, 1996 and 1997:
1996 1997 ----------- ----------- A-Term Loan Commitment payable in quarterly in- stallments through December 2001 with interest payable monthly at the Company's option of either the Bank's prime rate plus 1.75%, or LIBOR plus 2.75% (8.31% at December 31, 1996)................ $29,000,000 B-Term Loan Commitment payable in quarterly in- stallments through December 2003 with interest payable monthly at the Company's option of either the Bank's prime rate plus 2.25%, or the LIBOR plus 3.25% (8.81% at December 31, 1996)........... 28,000,000 A-Term Loan Commitment payable in quarterly in- stallments through December 2001 with interest payable monthly at the Company's option of either the Bank's prime rate or LIBOR plus additional ba- sis points ranging from 0.25% to 2.50% depending upon the Company's leverage ratio as defined in the agreement (7.0% at December 31, 1997)......... $ 8,567,704 B-Term Loan Commitment payable in quarterly in- stallments through December 2003 with interest payable monthly at the Company's option of either the Bank's prime rate or LIBOR plus additional ba- sis points ranging from 0.50% to 2.75% depending upon the Company's leverage ratio as defined in the agreement (7.25% at December 31, 1997)........ 8,663,611 8% Senior Subordinated Notes with detachable war- rants due November 2004, net of unamortized dis- count of $1,996,031, 11.19% effect interest rate.. 6,003,969 Subordinated seller notes, non-collateralized net of unamortized discount of $612,696 and $444,776 at December 31, 1996 and 1997, respectively, with principal and interest payable in either monthly or quarterly installments at effective interest rates ranging from 6% to 11%, maturing through January 2009...................................... 5,574,793 11,256,699 Other miscellaneous obligations with principal and interest payable in either monthly or annual in- stallments at interest rates ranging from 6% to 10% maturing through December 2007................ 621,611 497,172 ----------- ----------- 69,200,373 28,985,186 Less current portion............................... 4,902,572 5,747,865 ----------- ----------- $64,297,801 $23,237,321 =========== ===========
In November 1996, the Company entered into a new $90,000,000 Credit Agreement "Credit Agreement" with a syndication of banks which provided for a: (i) "A-Term Loan" in the principal amount of $29,000,000; (ii) "B-Term Loan" in the principal amount of $28,000,000; (iii) $25,000,000 Acquisition Loan Commitment and; (iv) $8,000,000 Revolving Loan Commitment. The Credit Agreement provided for an initial commitment fee of 2.625% on the total $90,000,000 facility and an annual fee of 0.5% per year on the aggregate unused portion of the Credit Agreement. As of December 31, 1996, the Company had no outstanding balances on both the Acquisition and Revolving Loan Commitments. F-12 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) In November 1996, the Company also entered into a Senior Subordinated Note Purchase Agreement in the principal amount of $8,000,000 whereby the Company issued 1,600,000 warrants to noteholders. This transaction resulted in the Company recording a debt discount of $2,038,500 which was being amortized over the life of the notes. The Company used the proceeds of the A-Term Loan, B-Term Loan and Senior Subordinated Notes to finance the acquisition of JEH and to repay all amounts then outstanding under the Company's former Revolving credit facility, Senior Financing Facility, the 8.5% Convertible Junior Subordinated Note and the 8.25% Convertible Junior Subordinate Note. In connection with this transaction, the Company recorded an extraordinary charge of $138,724 ($83,234, net of tax benefit) for the write-off of unamortized discounts and financing costs, in 1996. During July and August of 1997, the Company sold 5,750,000 shares of Common Stock in a underwritten public offering at $11.00 per share resulting in approximately $58.3 million of net proceeds to the Company. The Company applied the net proceeds of the public offering to the repayment of the Senior Subordinated Notes and certain indebtedness outstanding under the Credit Agreement. Upon repayment of this debt and the Credit Agreement being substantially modified, the Company incurred an extraordinary loss of $4.6 million ($2.7 million net of tax benefit). The modified Credit Agreement is collateralized by substantially all the assets of the Company, restricts the payment of dividends, and contains certain affirmative and negative covenants customary in an agreement of this nature. The remainder of the A-Term Loan, the $25,000,000 Acquisition Loan Commitment and the 8,000,000 Revolving Loan Commitment bears base interest at the Company's option of either LIBOR plus 2.50% or the Bank's prime rate plus 1.50%. The base interest rate is then reduced by 0.25% to 1.25% depending upon the ratio of the Company's total indebtedness to annual earnings before interest, taxes, depreciation and amortization. As of December 31, 1997, the Company had no outstanding balances on both the Acquisition and Revolving Loan Commitments. The remainder of the B-Term Loan bears base interest at the Company's option of either LIBOR plus 2.75% or the Bank's prime rate plus 1.75%. The base interest rate is then reduced by 0.25% to 1.25% depending upon the ratio of the Company's total indebtedness to annual earnings before interest, taxes, depreciation and amortization. The Company has entered into an interest rate swap agreement to reduce the impact of changes in interest rates on amounts outstanding on its Credit Agreement. At December 31, 1997, the Company had an outstanding interest rate swap agreement with a commercial bank, having a total notional principal amount of up to $26,950,000. The agreement effectively minimizes the Company's base interest rate exposure between a floor of 5.32% and a cap of 7%. The interest rate swap agreement matures on September 30, 1999. The Company is exposed to credit loss in the event of non-performance by the other party to the interest rate swap agreement. However, the Company does not anticipate non-performance by the counterparties. F-13 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Maturities of long-term debt, at December 31, 1997, are as follows: 1998.......................................................... $ 5,747,865 1999.......................................................... 4,952,369 2000.......................................................... 4,431,531 2001.......................................................... 4,553,149 2002.......................................................... 4,763,946 Thereafter.................................................... 4,536,326 ----------- $28,985,186 ===========
NOTE H--INCOME TAXES The provisions for income taxes for the years ended December 31, 1995, 1996 and 1997 consisted of the following:
1995 1996 1997 ---------- ---------- ---------- Current: Federal............................... $ 541,626 $1,146,564 $3,067,546 State................................. 370,973 427,441 398,153 ---------- ---------- ---------- Total................................... 912,599 1,574,005 3,465,699 Deferred: Federal and State..................... 631,899 (684,119) 2,060,301 ---------- ---------- ---------- Provision for income taxes on income before extraordinary item.............. 1,544,498 889,886 5,526,000 Tax benefit from extraordinary item..... (55,489) (1,950,700) ---------- ---------- ---------- Provision for income taxes.............. $1,544,498 $ 834,397 $3,575,300 ========== ========== ==========
A reconciliation of the federal statutory tax rate to the effective tax rate for the years ended December 31, 1995, 1996 and 1997 is as follows:
1995 1996 1997 ---------- -------- ---------- Federal statutory tax rate............... $1,251,349 $670,145 $4,608,106 Increase (reduction) in taxes resulting from: State income taxes (net of federal ef- fect)................................... 249,047 98,573 606,397 Amortization of the excess cost over net assets acquired......................... 92,777 92,777 95,506 Valuation allowance...................... (70,000) Other, net............................... 21,325 28,391 215,991 ---------- -------- ---------- Provision for income taxes on income be- fore extraordinary item................. 1,544,498 889,886 5,526,000 Tax benefit from extraordinary item...... (55,489) (1,950,700) ---------- -------- ---------- Provision for income taxes............... $1,544,498 $834,397 $3,575,300 ========== ======== ==========
F-14 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Temporary differences and carryforwards which give rise to deferred tax assets and liabilities as of December 31, 1996 and 1997 are as follows:
1996 1997 ---------- ----------- Deferred Tax Liabilities: Book basis in excess of tax......................... $ 775,838 $ 798,657 Depreciation and amortization....................... 2,498,527 3,212,106 ---------- ----------- 3,274,365 4,010,763 ---------- ----------- Deferred Tax Assets: Net operating loss, Federal......................... 319,039 276,272 Net operating loss, States.......................... 281,051 6,735 Accrued expenses.................................... 1,554,907 1,097,339 Reserve for bad debts............................... 965,116 12,382 Inventory capitalization and reserves............... 664,371 1,069,421 Acquisition costs................................... 271,534 269,966 ---------- ----------- Gross deferred tax assets........................... 4,056,018 2,732,115 ---------- ----------- Net deferred tax assets (liabilities)............... $ 781,653 $(1,278,648) ========== ===========
For Federal tax purposes at December 31, 1997, the Company has available approximately $789,000 of net operating loss carryforwards expiring from 1998 through 2007 and are subject to a limitation in their utilization of approximately $149,000 per year as a result of several changes in shareholder control. At December 31, 1995, the Company evaluated the realizability of the state net operating losses and, based upon projections of taxable income by state, concluded that a valuation allowance was not necessary. The remaining balance of the deferred tax assets should be realized through future taxable income and the reversal of taxable temporary differences. NOTE I--DEFERRED COMPENSATION In conjunction with the JEH acquisition, the Company assumed the unfunded deferred compensation plan that had been established for certain key JEH officers. The plan accrues benefits ratably over the period of active employment from the time the contract is entered into to the time the participant retires. Participation had been determined by JEH's Board of Directors. The Company has purchased individual life insurance contracts with respect to each employee covered by this plan. The Company is the owner and beneficiary of the insurance contracts. The accrual related to the deferred compensation arrangements amounted to approximately $1,985,000 and $2,099,000 at December 31, 1996 and 1997, respectively. NOTE J--COMMITMENTS AND CONTINGENT LIABILITIES The Company is engaged in legal proceedings in the normal course of business. The Company believes that any unfavorable outcome from these suits not covered by insurance would not have a material adverse effect on the financial statements of the Company. F-15 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE K--OPERATING LEASES The Company leases office space under noncancellable operating leases. Certain of these leases contain escalation clauses based on the consumer price index. Future minimum rental payments, by year and in the aggregate, under operating leases with terms of one year or more consist of the following at December 31, 1997: 1998............................................................. $ 4,169,000 1999............................................................. 3,386,000 2000............................................................. 2,803,000 2001............................................................. 2,264,000 2002............................................................. 1,388,000 Thereafter....................................................... 1,296,000 ----------- $15,306,000 ===========
Rent expense was approximately $2,144,000, $2,554,000 and $4,509,000 for the years ended December 31, 1995, 1996 and 1997, respectively. NOTE L--PENSION AND PROFIT SHARING PLANS Previously, the Company had a 401(k) Saving and Retirement Plan (the "Plan") available to all employees of J.E. Hanger, Inc. ("J.E. Hanger"), a wholly- owned subsidiary of the Company. The Company matched the participant's contributions and made discretionary matching contributions. On January 1, 1993, the Company froze the Plan such that no new employees of J.E. Hanger were able to participate. On December 31, 1995, the Company terminated the Plan. There was no employer contribution made to the Plan in 1995. The Company maintains a separate defined contribution profit sharing and 401(k) plan ("JEH Plan") covering all the employees of JEH, a wholly-owned subsidiary of the Company acquired November 1, 1996. On this date, the Company froze the JEH Plan such that no new employees of JEH were able to participate. The Company did not incur any expense in connection with this plan during the years ended December 31, 1996 and 1997. On January 1, 1998 the JEH Plan was merged into the Company's 401(k) Savings and Retirement Plan. The Company maintains a 401(k) Savings and Retirement plan to cover all of the employees of the Company. The Company may make discretionary contributions. Under this 401(k) plan, employees may defer such amounts of their compensation up to the levels permitted by the Internal Revenue Service. The Company has not made any contributions to this plan. NOTE M--REDEEMABLE PREFERRED STOCKS The Company has 10,000,000 authorized shares of preferred stock, par value $0.01 per share, which may be issued in various classes with different characteristics. The 300 issued and outstanding shares of non-voting, non-convertible Class C preferred stock have an aggregate liquidation value equal to $150,000 plus accrued dividends at 9% and are required to be redeemed on February 1, 2000. Accrued dividends at December 31, 1996 and 1997, were $616,124 and $642,176, respectively. The 100,000 authorized shares of Class F preferred stock, accrues dividends cumulatively at 16.5% and is required to be redeemed prior to any other class of preferred stock, before September 1998, for the aggregate liquidation value of $1,000 per share, plus accrued dividends. As of December 31, 1996 and 1997, none of the Class F preferred stock was issued or outstanding. F-16 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE N--WARRANTS AND OPTIONS WARRANTS In November 1990, the Company entered into a $2,450,000 Note which required the Company, based on certain repayment provisions, to issue to an affiliate in 1991 warrants to purchase 297,883 and 322,699 shares of common stock at $4.16 and $7.65 per share, respectively. These warrants are exercisable through December 31, 2001. In May 1996, 71,969 warrants were exercised at $4.16 per share which resulted in the issuance of 11,332 shares. In May 1997, 77,964 warrants were exercised at $7.65 per share which resulted in the issuance of 11,694 shares. In November 1996, the Company issued warrants for 1.6 million shares of common stock to the holders of the Senior Subordinated Notes. In August 1997, the Company repaid these Notes with the proceeds from the public offering. In accordance with the Senior Subordinate Note Agreement, 880,000 warrants were terminated. The remaining 720,000 warrants provide that the noteholders may purchase 418,365 shares and 301,635 shares for $4.01 and $6.375, respectively. The warrants are exercisable through November 1, 2004. In November 1996, the Company issued warrants for 35,000 shares of common stock as an incentive to one JEH noteholder to allow the notes to be assumed by the Company under the same terms and conditions that had existed prior to the acquisition. In January 1997, the noteholder exercised the warrants and purchased 35,000 shares of common stock for $2.44 per share. OPTIONS Under the Company's 1991 Stock Option Plan ("SOP"), 1,500,000 shares of Common Stock are authorized for issuance under options that may be granted to employees. The number of shares available for grant at December 31, 1996 was 113,501. There were no shares available for grant at December 31, 1997. Under the SOP, options may be granted at an exercise price not less than the fair market value of the Common Stock on the date of grant. Vesting and expiration periods are established by the Compensation Committee of the Board of Directors and generally vest three years following grant and generally expire eight to ten years after grant. Under the Company's 1993 Non-Employee Director Stock Option Plan, 250,000 shares of Common Stock are authorized for issuance to directors of the Company who are not employed by the Company or any affiliate of the Company. Under this plan, an option to purchase 5,000 shares of Common Stock is granted automatically on an annual basis to each eligible director on the third business day following the date of each Annual Meeting of Stockholders of the Company at which the eligible director is elected. The exercise price of each option will be equal to 100% of the fair market value of the Common Stock on the date of grant. Each option will vest at the rate of 25% each year for the first four years after the date of grant of the option and each such option expires ten years from the date of grant; provided, however, that in the event of termination of a director's service other than by reason of total and permanent disability or death, then the outstanding options of such holder expires three months after such termination. Outstanding options remain exercisable for one year after termination of service by reason of total and permanent disability or death. The number of shares that remain available for grant at December 31, 1996 and 1997 were 130,000 and 95,000, respectively. In addition to the SOP, non-qualified options may be granted with exercise prices that are less than the current market value. Accordingly, compensation expense for the difference between current market value and exercise price is recorded at the date of grant. F-17 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The following is a summary of option transactions and exercise prices:
NON- STOCK OPTION PLAN QUALIFIED STOCK OPTIONS -------------------------- ------------------------ PRICE WEIGHTED PRICE WEIGHTED SHARES PER SHARE AVERAGE SHARES PER SHARE AVERAGE --------- --------------- -------- ------- --------------- -------- Outstanding at December 31, 1994............... 418,874 $6.00 to $12.25 6.57 130,000 $4.38 to $12.00 7.78 ========= ======= Granted................. 171,918 $2.75 to $3.25 2.83 37,500 $3.00 3.00 Terminated.............. (57,291) $6.00 to $12.25 7.20 -- --------- ------- Outstanding at December 31, 1995............... 533,501 $2.75 to $12.25 5.49 167,500 $3.00 to $12.00 6.81 ========= ======= Granted................. 802,250 $3.50 to $6.125 5.54 30,000 $5.875 5.875 Terminated.............. (22,961) $2.81 to $12.25 4.93 -- Exercised............... (7,508) $2.81 2.81 (6,250) $3.00 to $12.00 4.75 --------- ------- Outstanding at December 31, 1996............... 1,305,282 $2.75 to $12.25 5.54 191,250 $3.00 to $12.00 6.74 ========= ======= Granted................. 675,000 $6.00 to $13.25 9.95 35,000 $8.75 8.75 Terminated.............. (34,984) $2.81 to $13.25 6.69 -- Expired................. (6,250) $7.12 7.12 Exercised............... (388,915) $2.75 to $12.25 5.78 (19,375) $3.00 to $6.52 4.91 --------- ------- Outstanding at December 31, 1997............... 1,556,383 $2.75 to $13.25 7.42 200,625 $3.00 to $12.00 7.27 ========= ======= Vested at December 31, 1997................... 322,347 120,625 ========= =======
The Company applies APB Opinion 25 "Accounting for Stock Issued to Employees," and related Interpretations in accounting for its plans. Historically, the Company granted stock options at exercise prices equal to the fair market value of the stock on the date of grant for fixed stock options. Accordingly, no compensation cost has been recognized for its fixed stock option plans. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS 123, "Accounting for Stock-Based Compensations" the Company's net income and earnings per share would have been reduced to the unaudited pro forma amounts indicated below:
1995 1996 1997 ---------- -------- ---------- Net Income: As reported $2,135,439 $997,894 $4,946,228 Pro Forma 2,017,179 745,714 4,010,102 Diluted Income Per Common Share: As reported $0.26 $0.11 $0.37 Pro Forma $0.24 $0.08 $0.31
The following is a summary of stock options exercisable at December 31, 1995, 1996 and 1997, and their respective weighted average share prices:
WEIGHTED NUMBER AVERAGE OF SHARES EXERCISE PRICE --------- -------------- Options exercisable December 31, 1995............... 396,043 $6.83 Options exercisable December 31, 1996............... 525,282 6.45 Options exercisable December 31, 1997............... 442,972 5.66
F-18 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The pro forma information regarding net income and earnings per share is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS 123. The fair value for these options was estimated at the date of grant using a Black- Scholes option pricing model with the following weighted average assumptions for 1995, 1996 and 1997:
1995 1996 1997 ----- ----- ----- Expected term........................................... 7 7 5 Volatility factor....................................... 120% 120% 58% Risk free interest rate................................. 6.8% 6.7% 6.3% Dividend yield.......................................... 0% 0% 0% Fair value.............................................. $2.51 $5.03 $4.99
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The following table summarizes information concerning outstanding and exercisable options as of December 31, 1997:
OPTIONS OUTSTANDING ------------------------------- NUMBER OF WEIGHTED AVERAGE OPTIONS EXERCISABLE RANGE OF OPTIONS --------------------- ---------------------------------- EXERCISE AND REMAINING EXERCISE NUMBER OF OPTIONS WEIGHTED AVERAGE PRICES AWARDS LIFE (YEARS) PRICE AND AWARDS EXERCISE PRICE -------- --------- ------------ -------- ----------------- ---------------- $ 2.750 to $ 3.500 207,130 7.79 $3.19 75,463 $3.08 4.125 to 4.125 74,086 8.22 4.13 21,558 4.13 4.375 to 6.000 240,250 7.42 5.82 110,250 5.75 6.125 to 6.125 665,417 8.89 6.13 157,076 6.13 6.250 to 6.250 5,000 5.70 6.25 5,000 6.25 6.520 to 8.750 40,625 9.31 8.68 625 6.52 11.313 to 11.313 339,000 9.96 11.31 0 0.00 12.000 to 13.250 185,500 7.62 12.72 73,000 12.08 ------- --------- ---- ----- ------- ----- $ 2.750 to $13.250 1,757,008 8.60 $7.41 442,972 $6.40
F-19 HANGER ORTHOPEDIC GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE O--QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Summarized unaudited quarterly financial data for the years ended December 31, 1996 and 1997 are:
QUARTER ENDED ----------------------------------------- MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 -------- ------- ------------ ----------- (IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 Net Sales........................ $30,950 $36,645 $38,840 $39,164 Gross Profit..................... 14,720 18,323 19,059 19,963 Income before extraordinary item............................ 618 1,852 2,239 2,931 Extraordinary loss on early extinguishment of debt, net of tax benefit..................... (2,693) Net income (loss)................ 618 1,852 (454) 2,931 DILUTED PER COMMON SHARE DATA (1) Income before extraordinary item............................ 0.06 0.18 0.15 0.17 Extraordinary item, net of tax benefit......................... (0.18) Net income (loss)................ 0.06 0.18 (0.03) 0.17 1996 (2) Net Sales........................ $12,230 $14,021 $14,529 $26,027 Gross Profit..................... 6,344 7,667 8,039 12,523 Income (loss) before extraordinary item.............. 150 738 850 (658) Extraordinary loss on early extinguishment of debt, net of tax............................. (83) Net income (loss)................ 150 738 850 (741) DILUTED PER COMMON SHARE DATA (1) Income (loss) before extraordinary item.............. 0.02 0.09 0.10 (0.07) Extraordinary item, net of tax benefit......................... (0.01) Net income (loss) share.......... 0.02 0.09 0.10 (0.08)
- -------- (1) During the fourth quarter of 1977, the Company adopted the provisions of SFAS 128 and, as required, has restated all prior period per common share data. (2) Includes fourth quarter pre-tax charges of $2,479 for acquisition and integration costs incurred in connection with the purchase of JEH. F-20 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- NO PERSON HAS BEEN AUTHORIZED IN CONNECTION WITH THE OFFERING MADE HEREBY TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, THE SELLING STOCKHOLDERS OR ANY UNDERWRITER WITH RESPECT TO ANY SALES HEREUNDER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSON OR BY ANYONE IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATIONS THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF. ---------------- TABLE OF CONTENTS
PAGE ---- Prospectus Summary....................................................... 4 Risk Factors............................................................. 8 Use of Proceeds.......................................................... 11 Dividend Policy.......................................................... 12 Price Range of Common Stock.............................................. 12 Capitalization........................................................... 13 Selected Historical and Pro Forma Consolidated Financial Information..... 14 Selected Unaudited Pro Forma Condensed Consolidated Financial Information............................................................. 17 Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................... 24 Business................................................................. 33 Management............................................................... 43 Principal and Selling Stockholders....................................... 46 Underwriting............................................................. 47 Legal Matters............................................................ 48 Experts.................................................................. 48 Available Information.................................................... 49 Documents Incorporated by Reference...................................... 49 Index to Financial Statements............................................ F-1
---------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 3,300,000 Shares [LOGO OF HANGER ORTHOPEDIC GROUP INC.] Common Stock ---------------- PROSPECTUS ---------------- BT ALEX. BROWN NATIONSBANC MONTGOMERY SECURITIES LLC LEGG MASON WOOD WALKER INCORPORATED , 1998 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- PART II. INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.* The fees and expenses to be paid in connection with the issuance and distribution of securities being registered hereby will be paid by the Registrant as follows: SEC registration fee.......................................... $ 22,320.53 Blue Sky fees and expenses (including legal fees)............. 2,500.00 Printing...................................................... 125,000.00 Legal fees and expenses....................................... 300,000.00 American Stock Exchange listing fee........................... 17,500.00 NASD filing fee............................................... 8,067.00 Accounting fees and expenses.................................. 150,000.00 Miscellaneous................................................. 24,612.47 ----------- Total....................................................... $650,000.00 ===========
- -------- * All expenses are estimated except the SEC registration fee. ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS. Hanger is permitted by Delaware law and required by its Certificate of Incorporation and its By-laws to indemnify any director or officer or former director of officer against all expenses and liabilities reasonably incurred by him in connection with any legal action in which such person is involved by reason of his position with Hanger unless he is adjudged liable for negligence or misconduct in the performance of his duties as a director or officer. If any such action is settled, Hanger will provide indemnification only if the Board of Directors approves such settlement after receiving an opinion of counsel for Hanger that settlement is in Hanger's best interest. Reference is made to Section 8 of the Underwriting Agreement (included herein as a part of Exhibit 1) which contains provisions for the indemnification by the Underwriters of Hanger and directors, officers and controlling persons of Hanger and the Selling Stockholders under certain circumstances. ITEM 16. EXHIBITS The following documents are filed herewith: Exhibits 1 Form of Underwriting Agreement Legal opinion, dated June 11, 1998, of Freedman, Levy, Kroll & 5 Simonds. Consent of Freedman, Levy, Kroll & Simonds. (Included in Exhibit No. 5 23(a) hereto.) 23(b) Consent of Coopers & Lybrand L.L.P. 24 Power of Attorney. (Included on page II-6.)
ITEM 17. UNDERTAKINGS. The undersigned Registrant hereby undertakes: (1) The undersigned registrant hereby undertakes that, for purposes of determining any liability under the Securities Act of 1933, each filing of the registrant's annual report pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (and, where applicable, each filing of an employee benefit plan's annual report pursuant to Section 15(d) of the Securities Exchange Act of 1934) that is incorporated by reference in the registration statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be that initial bona fide offering thereof. II-1 (2) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of the registration statement as of the time it was declared effective. (3) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue. II-2 SIGNATURES PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT CERTIFIES THAT IT HAS REASONABLE GROUNDS TO BELIEVE THAT IT MEETS ALL OF THE REQUIREMENTS FOR FILING ON FORM S-3 AND HAS DULY CAUSED THIS REGISTRATION STATEMENT OR AMENDMENT THERETO TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF BETHESDA, STATE OF MARYLAND, ON THIS 11TH DAY OF JUNE, 1998. Hanger Orthopedic Group, Inc. (Registrant) Ivan R. Sabel By: _________________________________ IVAN R. SABEL Chairman of the Board, President and Chief Executive Officer KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints IVAN R. SABEL and RICHARD A. STEIN his true and lawful attorneys-in-fact and agents, each acting alone, with full powers of substitution, for him and in his name, place and stead, in any and all capacities, to sign any or all amendments (including post-effective amendments) to this Registration Statement, and to file the same, with exhibits thereto, and other documents in connection therewith, including any subsequent registration statement filed by the Registrant pursuant to Rule 462(b) under the Securities Act of 1933, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, each acting alone, full power and authority to do and perform to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, each acting alone, or his substitute or substitutes, may lawfully do or cause to be done by virtue thereof. PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS REGISTRATION STATEMENT OR AMENDMENT THERETO HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE DATES INDICATED: SIGNATURE TITLE DATE --------- ----- ---- Ivan R. Sabel Chairman of the June 11, 1998 - ------------------------------------- Board, Chief IVAN R. SABEL Executive Officer and Director (Principal Executive Officer) Richard A. Stein Vice President-- June 11, 1998 - ------------------------------------- Finance, Treasurer RICHARD A. STEIN and Secretary (Principal Financial and Accounting Officer) Mitchell J. Blutt Director June 11, 1998 - ------------------------------------- MITCHELL J. BLUTT, M.D. Edmond E. Charrette Director June 11, 1998 - ------------------------------------- EDMOND E. CHARRETTE, M.D. II-3 SIGNATURE TITLE DATE --------- ----- ---- Thomas P. Cooper Director June 11, 1998 - ------------------------------------- THOMAS P. COOPER, M.D. Robert J. Glaser Director June 11, 1998 - ------------------------------------- ROBERT J. GLASER, M.D. James G. Hellmuth Director June 11, 1998 - ------------------------------------- JAMES G. HELLMUTH William L. McCulloch Director June 11, 1998 - ------------------------------------- WILLIAM L. MCCULLOCH H.E. Thranhardt Director June 11, 1998 - ------------------------------------- H.E. THRANHARDT Risa J. Lavizzo-Mourey Director June 11, 1998 - ------------------------------------- RISA J. LAVIZZO-MOUREY, M.D. II-4 EXHIBIT INDEX Exhibits 1 Form of Underwriting Agreement. Legal opinion, dated June 11, 1998, of Freedman, Levy, Kroll & 5 Simonds. Consent of Freedman, Levy, Kroll & Simonds. (Included in Exhibit No. 5 23(a) hereto.) 23(b) Consent of Coopers & Lybrand L.L.P. 24 Power of Attorney. (Included on page II-6.)
EX-1 2 EXHIBIT 1 - FORM OF UNDERWRITING AGREEMENT 3,300,000 Shares Hanger Orthopedic Group, Inc. Common Stock ($.01 Par Value) UNDERWRITING AGREEMENT ---------------------- ______________, 1998 BT Alex. Brown Incorporated NationsBanc Montgomery Securities LLC Legg Mason Wood Walker, Incorporated As Representatives of the Several Underwriters c/o BT Alex. Brown Incorporated One South Street Baltimore, Maryland 21202 Gentlemen: Hanger Orthopedic Group, Inc., a Delaware corporation (the "Company"), and certain stockholders of the Company (the "Selling Stockholders") propose to sell to the several underwriters (the "Underwriters") named in Schedule I hereto for whom you are acting as representatives (the "Representatives") an aggregate of 3,300,000 shares of the Company's Common Stock, $.01 par value (the "Firm Shares"), of which 2,400,000 shares will be sold by the Company and 900,000 shares will be sold by the Selling Stockholders. The respective amounts of the Firm Shares to be so purchased by the several Underwriters are set forth opposite their names in Schedule I hereto, and the respective amounts to be sold by the Selling Stockholders are set forth opposite their names in Schedule II hereto. The Company and the Selling Stockholders are sometimes referred to collectively as the "Sellers." The Company also proposes to sell to the Underwriters at the Underwriters' option an aggregate of up to _________ additional shares of the Company's Common Stock (the "Option Shares") as set forth below. As the Representatives, you have advised the Company and the Selling Stockholders (a) that you are authorized to enter into this Agreement on behalf of the several Underwriters, and (b) that the several Underwriters are willing, acting severally and not jointly, to purchase the numbers of Firm Shares set forth opposite their respective names in Schedule I, plus their pro rata portion of the Option Shares if you elect to exercise the over-allotment option in whole or in part for the accounts of the several Underwriters. The Firm Shares and the Option Shares (to the extent the aforementioned option is exercised) are herein collectively called the "Shares." In consideration of the mutual agreements contained herein and of the interests of the parties in the transactions contemplated hereby, the parties hereto agree as follows: 1. REPRESENTATIONS AND WARRANTIES OF THE COMPANY AND THE SELLING ------------------------------------------------------------- STOCKHOLDERS. ------------ (a) The Company represents and warrants to each of the Underwriters and the Selling Stockholders as follows: (i) A registration statement on Form S-3 (File No. ________) with respect to the Shares has been carefully prepared by the Company in conformity with the requirements of the Securities Act of 1933, as amended (the "Act"), and the Rules and Regulations (the "Rules and Regulations") of the Securities and Exchange Commission (the "Commission") thereunder and has been filed with the Commission. Form S-3 is available for use by the Company. Copies of such registration statement, including any amendments thereto, the preliminary prospectuses (meeting the requirements of the Rules and Regulations) contained therein and the exhibits, financial statements and schedules, as finally amended and revised, have heretofore been delivered by the Company to you. Such registration statement, together with any registration statement filed by the Company pursuant to Rule 462(b) of the Act, herein referred to as the "Registration Statement," which shall be deemed to include all information omitted therefrom in reliance upon Rule 430A and contained in the Prospectus referred to below, has become effective under the Act and no post-effective amendment to the Registration Statement has been filed as of the date of this Agreement. "Prospectus" means (a) the form of prospectus first filed with the Commission pursuant to Rule 424(b) or (b) the last preliminary prospectus included in the Registration Statement filed prior to the time it becomes effective or filed pursuant to Rule 424(a) under the Act that is delivered by the Company to the Underwriters for delivery to purchasers of the Shares, together with the term sheet or abbreviated term sheet filed with the Commission pursuant to Rule 424(b)(7) under the Act. Each preliminary prospectus included in the Registration Statement prior to the time it becomes effective is herein referred to as a "Preliminary Prospectus." Any reference herein to the Registration Statement, any Preliminary Prospectus or to the Prospectus shall be deemed to refer to and include any documents incorporated by reference therein, and, in the case of any reference herein to any Prospectus, also shall be deemed to include any documents incorporated by reference therein, and any supplements or amendments thereto, filed with the Commission after the date of filing of the Prospectus under Rules 424(b) or 430A, and prior to the termination of the offering of the Shares by the Underwriters. (ii) The Company has been duly organized and is validly existing as a corporation in good standing under the laws of the State of Delaware, with corporate power and authority to own or lease its properties and conduct its business as described in 2 the Registration Statement. Each of the subsidiaries of the Company as listed in Exhibit A hereto (collectively, the "Subsidiaries") has been duly organized and is validly existing as a corporation in good standing under the laws of the jurisdiction of its incorporation, with corporate power and authority to own or lease its properties and conduct its business as described in the Registration Statement. The Subsidiaries are the only subsidiaries, direct or indirect, of the Company. The Company and each of the Subsidiaries are duly qualified to transact business in all jurisdictions in which the conduct of their business requires such qualification. The outstanding shares of capital stock of each of the Subsidiaries have been duly authorized and validly issued, are fully paid and non-assessable and are owned by the Company or another Subsidiary free and clear of all liens, encumbrances and equities and claims; and no options, warrants or other rights to purchase, agreements or other obligations to issue or other rights to convert any obligations into shares of capital stock or ownership interests in the Subsidiaries are outstanding. (iii) The outstanding shares of Common Stock of the Company, including all Shares to be sold by the Selling Stockholders, have been duly authorized and validly issued and are fully paid and non-assessable; the portion of the Shares to be issued and sold by the Company have been duly authorized and when issued and paid for as contemplated herein will be validly issued, fully paid and non-assessable; and no preemptive rights of stockholders exist with respect to any of the Shares or the issue and sale thereof. Neither the filing of the Registration Statement nor the offering or sale of the Shares as contemplated by this Agreement gives rise to any rights, other than those which have been waived or satisfied, for or relating to the registration of any shares of Common Stock. (iv) The information set forth under the caption "Capitalization" in the Prospectus is true and correct. All of the Shares conform to the description thereof contained in the Registration Statement. The form of certificates for the Shares conforms to the corporate law of the jurisdiction of the Company's incorporation. (v) The Commission has not issued an order preventing or suspending the use of any Prospectus relating to the proposed offering of the Shares nor instituted proceedings for that purpose. The Registration Statement contains, and the Prospectus and any amendments or supplements thereto will contain, all statements which are required to be stated therein by, and will conform, to the requirements of the Act and the Rules and Regulations. The documents incorporated by reference in the Prospectus, at the time filed with the Commission, conformed in all material respects to the requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or the Act, as applicable, and the rules and regulations of the Commission thereunder. The Registration Statement and any amendment thereto do not contain, and will not contain, any untrue statement of a material fact and do not omit, and will not omit, to state any material fact required to be stated therein or necessary to make the statements therein not misleading. The Prospectus and any amendments and supplements thereto do not contain, and will not contain, any untrue statement of material fact; and do not omit, and will not omit, to 3 state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; provided, however, that the Company makes no representations or warranties as to information contained in or omitted from the Registration Statement or the Prospectus, or any such amendment or supplement, in reliance upon, and in conformity with, written information furnished to the Company by or on behalf of any Underwriter through the Representatives, specifically for use in the preparation thereof. (vi) The consolidated financial statements of the Company and the Subsidiaries, together with related notes and schedules as set forth or incorporated by reference in the Registration Statement, present fairly the financial position and the results of operations and cash flows of the Company and the consolidated Subsidiaries, at the indicated dates and for the indicated periods. Such financial statements and related schedules have been prepared in accordance with generally accepted principles of accounting, consistently applied throughout the periods involved, except as disclosed herein, and all adjustments necessary for a fair presentation of results for such periods have been made. The summary financial and statistical data included or incorporated by reference in the Registration Statement presents fairly the information shown therein and such data has been compiled on a basis consistent with the financial statements presented therein and the books and records of the company. The pro forma financial statements and other pro forma financial information included in the Registration Statement and the Prospectus present fairly the information shown therein, have been prepared in accordance with the Commission's rules and guidelines with respect to pro forma financial statements, have been properly compiled on the pro forma bases described therein, and, in the opinion of the Company, the assumptions used in the preparation thereof are reasonable and the adjustments used therein are appropriate to give effect to the transactions or circumstances referred to therein. (vii) Coopers & Lybrand L.L.P., who have certified certain of the financial statements filed with the Commission as part of, or incorporated by reference in, the Registration Statement, are independent public accountants as required by the Act and the Rules and Regulations. (viii) There is no action, suit, claim or proceeding pending or, to the knowledge of the Company, threatened against the Company or any of the Subsidiaries before any court or administrative agency or otherwise which if determined adversely to the Company or any of its Subsidiaries might result in any material adverse change in the earnings, business, management, properties, assets, rights, operations, condition (financial or otherwise) or prospects of the Company and of the Subsidiaries taken as a whole or to prevent the consummation of the transactions contemplated hereby, except as set forth in the Registration Statement. (ix) The Company and the Subsidiaries have good and marketable title to all of the properties and assets reflected in the financial statements (or as described in the Registration Statement) hereinabove described, subject to no lien, mortgage, pledge, 4 charge or encumbrance of any kind except those reflected in such financial statements (or as described in the Registration Statement) or which are not material in amount. The Company and the Subsidiaries occupy their leased properties under valid and binding leases conforming in all material respects to the description thereof set forth or incorporated by reference in the Registration Statement. (x) The Company and the Subsidiaries have filed all Federal, State, local and foreign income tax returns which have been required to be filed and have paid all taxes indicated by said returns and all assessments received by them or any of them to the extent that such taxes have become due and are not being contested in good faith. All tax liabilities have been adequately provided for in the financial statements of the Company and the Company does not know of any actual or proposed additional material tax assessments. (xi) Since the respective dates as of which information is given in the Registration Statement, as it may be amended or supplemented, there has not been any material adverse change or any development involving a prospective material adverse change in or affecting the earnings, business, management, properties, assets, rights, operations, condition (financial or otherwise), or prospects of the Company and its Subsidiaries taken as a whole, whether or not occurring in the ordinary course of business, and there has not been any material transaction entered into or any material transaction that is probable of being entered into by the Company or the Subsidiaries, other than transactions in the ordinary course of business and changes and transactions described in the Registration Statement, as it may be amended or supplemented. The Company and the Subsidiaries have no material contingent obligations which are not disclosed in the Company's financial statements which are included in the Registration Statement. (xii) Neither the Company nor any of the Subsidiaries is, or with the giving of notice or lapse of time or both, will be, in violation of or in default under its Charter or By-Laws or under any agreement, lease, contract, indenture or other instrument or obligation to which it is a party or by which it, or any of its properties, is bound and which default is of material significance in respect of the condition, financial or otherwise of the Company and its Subsidiaries taken as a whole or the business, management, properties, assets, rights, operations, condition (financial or otherwise) or prospects of the Company and the Subsidiaries taken as a whole. The execution and delivery of this Agreement and the consummation of the transactions herein contemplated and the fulfillment of the terms hereof will not conflict with or result in a breach of any of the terms or provisions of, or constitute a default under, any indenture, mortgage, deed of trust or other agreement or instrument to which the Company or any Subsidiary is a party, or of the Charter or By-Laws of the Company or any order, rule or regulation applicable to the Company or any Subsidiary of any court or of any regulatory body or administrative agency or other governmental body having jurisdiction. 5 (xiii) Each approval, consent, order, authorization, designation, declaration or filing by or with any regulatory, administrative or other governmental body necessary in connection with the execution and delivery by the Company of this Agreement and the consummation of the transactions herein contemplated (except such additional steps as may be required by the Commission, the National Association of Securities Dealers, Inc. (the "NASD") or such additional steps as may be necessary to qualify the Shares for public offering by the Underwriters under state securities or Blue Sky laws) has been obtained or made and is in full force and effect. (xiv) The Company and each of the Subsidiaries holds all material licenses, certificates and permits from governmental authorities which are necessary to the conduct of their businesses; and neither the Company nor any of the Subsidiaries has infringed any patents, patent rights, trade names, trademarks or copyrights, which infringement is material to the business of the Company and the Subsidiaries taken as a whole. The Company knows of no material infringement by others of patents, patent rights, trade names, trademarks or copyrights owned by or licensed to the Company. (xv) Neither the Company, nor to the Company's best knowledge, any of its affiliates, has taken or may take, directly or indirectly, any action designed to cause or result in, or which has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of the shares of Common Stock to facilitate the sale or resale of the Shares. (xvi) Neither the Company nor any Subsidiary is an "investment company" within the meaning of such term under the Investment Company Act of 1940 and the rules and regulations of the Commission thereunder. (xvii) The Company maintains a system of internal accounting controls sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management's general or specific authorization; (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets; (iii) access to assets is permitted only in accordance with management's general or specific authorization; and (iv) the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (xviii) The Company and each of its Subsidiaries carry, or are covered by, insurance in such amounts and covering such risks as is adequate for the conduct of their respective businesses and the value of their respective properties and as is customary for companies engaged in similar industries. (xix) The Company is in compliance in all material respects with all presently applicable provisions of the Employee Retirement Income Security Act of 1974, as amended, including the regulations and published interpretations thereunder ("ERISA"); no "reportable event" (as defined in ERISA) has occurred with respect to any "pension 6 plan" (as defined in ERISA) for which the Company would have any liability; the Company has not incurred and does not expect to incur liability under (i) Title IV of ERISA with respect to termination of, or withdrawal from, any "pension plan" or (ii) Sections 412 or 4971 of the Internal Revenue Code of 1986, as amended, including the regulations and published interpretations thereunder (the "Code"); and each "pension plan" for which the Company would have any liability that is intended to be qualified under Section 401(a) of the Code is so qualified in all material respects and nothing has occurred, whether by action or by failure to act, which would cause the loss of such qualification. (xx) To the Company's knowledge, there are no affiliations or associations between any member of the NASD and any of the Company's officers, directors or 5% or greater securityholders, except as set forth in the Registration Statement. (xxi) Neither the Company nor any Subsidiary has engaged in any activities which are prohibited, or are cause for civil penalties or mandatory or permissive exclusion from Medicare or Medicaid, under Sections 1320a-7, 1320a-7a, 1320a-7b, or 1395nn of Title 42 of the United States Code, the federal CHAMPUS statute, or the regulations promulgated pursuant to such statutes or regulations or related state or local statutes or which are prohibited by any private accrediting organization from which the Company or any of its Subsidiaries seeks accreditation or by generally recognized professional standards of care or conduct. Neither the Company nor to the knowledge of the Company any other person who has a direct or indirect ownership or control interest in the Company or any Subsidiary or who is an officer, director, agent or managing employee of the Company or any Subsidiary: (1) has had a civil monetary penalty assessed against it under Section 1128A of the Social Security Act ("SSA"); (2) has been excluded from participation under the Medicare program or a Federal Health Care Program (as that term is defined in SSA Section 1128(B)(f)); or (3) has been convicted (as that term is defined in 42 C.F.R. (S) 1001.2) of any of the categories of offenses described in SSA Section 1128(a) and (b)(1), (2) and (3). (b) Each of the Selling Stockholders severally represents and warrants as follows: (i) Such Selling Stockholder now has and at the Closing Date (as such date is hereinafter defined) will have good and valid title to the Firm Shares to be sold by such Selling Stockholder, free and clear of any liens, encumbrances, equities and claims, and full right, power and authority to effect the sale and delivery of such Firm Shares; and upon the delivery of, against payment for, such Firm Shares pursuant to this Agreement, the Underwriters (assuming that they are bona fide purchasers within the meaning of the Uniform Commercial Code) will acquire good and valid title thereto, free and clear of any liens, encumbrances, equities and claims. (ii) Such Selling Stockholder has full right, power and authority to execute and deliver this Agreement, the Power of Attorney, and the Custody Agreement referred to below and to perform its obligations under such Agreements. The execution and delivery 7 of this Agreement and the consummation by such Selling Stockholder of the transactions herein contemplated and the fulfillment by such Selling Stockholder of the terms hereof will not require any consent, approval, authorization, or other order of any court, regulatory body, administrative agency or other governmental body (except as may be required under the Act, state securities laws or Blue Sky laws or the rules and regulations of the National Association of Securities Dealers, Inc.) and will not result in a material breach of any of the terms and provisions of, or constitute a material default under, organizational documents of such Selling Stockholder, if not an individual, or any indenture, mortgage, deed of trust or other agreement or instrument to which such Selling Stockholder is a party, or of any order, rule or regulation applicable to such Selling Stockholder of any court or of any regulatory body or administrative agency or other governmental body having jurisdiction. (iii) Such Selling Stockholder has not taken and will not take, directly or indirectly, any action designed to, or which has constituted, or which might reasonably be expected to cause or result in the stabilization or manipulation of the price of the Common Stock of the Company and, other than as permitted by the Act, the Selling Stockholder will not distribute any prospectus or other offering material in connection with the offering of the Shares. (iv) Without having undertaken to determine independently or independently verify the accuracy or completeness of either the representations and warranties of the Company contained herein or the information contained in the Registration Statement, such Selling Stockholder has no reason to believe that the representations and warranties of the Company contained in this Section 1(a) are not true and correct, is familiar with the Registration Statement and has no knowledge of any material fact, condition or information not disclosed in the Registration Statement which has adversely affected or is reasonably likely to adversely affect the business of the Company and its Subsidiaries taken as a whole; and the sale of the Firm Shares by such Selling Stockholder pursuant hereto is not prompted by any material information concerning the Company or any of the Subsidiaries which is not set forth in the Registration Statement or the documents incorporated by reference therein and which is reasonably likely to have an affect on the business of the Company and its Subsidiaries, taken as a whole. The information pertaining to such Selling Stockholder under the caption "Principal and Selling Stockholders" in the Prospectus is complete and accurate in all material respects. 2. PURCHASE, SALE AND DELIVERY OF THE FIRM SHARES. ---------------------------------------------- (a) On the basis of the representations, warranties and covenants herein contained, and subject to the conditions herein set forth, the Sellers agree to sell to the Underwriters and each Underwriter agrees, severally and not jointly, to purchase, at a price of $______ per share, the number of Firm Shares set forth opposite the name of each Underwriter in Schedule I hereof, subject to adjustments in accordance with Section 9 hereof. The number of Firm Shares to be purchased by each Underwriter from each Seller shall be as nearly as practicable in the same proportion to the total number of 8 Firm Shares being sold by each Seller as the number of Firm Shares being purchased by each Underwriter bears to the total number of Firm Shares to be sold hereunder. The obligations of the Company and of each of the Selling Stockholders shall be several and not joint. (b) Certificates in negotiable form for the total number of the Shares to be sold hereunder by the Selling Stockholders have been placed in custody with ChaseMellon Bank as custodian (the "Custodian") pursuant to the Custody Agreement executed by each Selling Stockholder for delivery of all Firm Shares to be sold hereunder by the Selling Stockholders. Each of the Selling Stockholders specifically agrees that the Firm Shares represented by the certificates held in custody for the Selling Stockholders under the Custody Agreement are subject to the interests of the Underwriters hereunder, that the arrangements made by the Selling Stockholders for such custody are to that extent irrevocable, and that the obligations of the Selling Stockholders hereunder shall not be terminable by any act or deed of the Selling Stockholders (or by any other person, firm or corporation including the Company, the Custodian or the Underwriters) or by operation of law (including the death of an individual Selling Stockholder or the dissolution of a Selling Stockholder that is not an individual) or by the occurrence of any other event or events, except as set forth in the Custody Agreement. If any such event (other than as provided in the Custody Agreement) should occur prior to the delivery to the Underwriters of the Firm Shares hereunder, certificates for the Firm Shares shall be delivered by the Custodian in accordance with the terms and conditions of this Agreement as if such event has not occurred. The Custodian is authorized to receive and acknowledge receipt of the proceeds of sale of the Shares held by it against delivery of such Shares. (c) Payment for the Firm Shares to be sold hereunder is to be made by wire transfer of immediately available funds to an account designated by the Company for the shares to be sold by it and to an account designated by ChaseMellon Bank "as Custodian" for the shares to be sold by the Selling Stockholders, in each case against delivery of certificates therefor to the Representatives for the several accounts of the Underwriters. Such payment and delivery are to be made at the offices of BT Alex. Brown Incorporated, One South Street, Baltimore, Maryland, at 10:00 a.m., Baltimore time, on the third business day after the date of this Agreement or at such other time and date not later than five business days thereafter as you and the Company shall agree upon, such time and date being herein referred to as the "Closing Date." (As used herein, "business day" means a day on which the New York Stock Exchange is open for trading and on which banks in New York are open for business and are not permitted by law or executive order to be closed.) The certificates for the Firm Shares will be delivered in such denominations and in such registrations as the Representatives request in writing not later than the second full business day prior to the Closing Date, and will be made available for inspection by the Representatives at least one business day prior to the Closing Date. (d) In addition, on the basis of the representations and warranties herein contained and subject to the terms and conditions herein set forth, the Company hereby 9 grants an option to the several Underwriters to purchase the Option Shares at the price per share as set forth in the first paragraph of this Section 2. The option granted hereby may be exercised in whole or in part by giving written notice (i) at any time before the Closing Date and (ii) only once thereafter within 30 days after the date of this Agreement, by you, as Representatives of the several Underwriters, to the Company setting forth the number of Option Shares as to which the several Underwriters are exercising the option, the names and denominations in which the Option Shares are to be registered and the time and date at which such certificates are to be delivered. The time and date at which certificates for Option Shares are to be delivered shall be determined by the Representatives but shall not be earlier than three nor later than 10 full business days after the exercise of such option, nor in any event prior to the Closing Date (such time and date being herein referred to as the "Option Closing Date"). If the date of exercise of the option is three or more days before the Closing Date, the notice of exercise shall set the Closing Date as the Option Closing Date. The number of Option Shares to be purchased by each Underwriter shall be in the same proportion to the total number of Option Shares being purchased as the number of Firm Shares being purchased by such Underwriter bears to ____________, adjusted by you in such manner as to avoid fractional shares. The option with respect to the Option Shares granted hereunder may be exercised only to cover over- allotments in the sale of the Firm Shares by the Underwriters. You, as Representatives of the several Underwriters, may cancel such option at any time prior to its expiration by giving written notice of such cancellation to the Company. To the extent, if any, that the option is exercised, payment for the Option Shares shall be made on the Option Closing Date by wire transfer of immediately available funds to an account designated by the Company against delivery of certificates therefor at the offices of BT Alex. Brown Incorporated, One South Street, Baltimore, Maryland. (e) If on the Closing Date, any Selling Stockholder fails to sell the Firm Shares which such Selling Stockholder has agreed to sell on such date as set forth in Schedule II hereto, the Company agrees that it will sell or ----------- arrange for the sale of that number of shares of Common Stock to the Underwriters which represents Firm Shares which such Selling Stockholder has failed to so sell, as set forth in Schedule II hereto, or such lesser ----------- number as may be requested by the Representatives. 3. OFFERING BY THE UNDERWRITERS. ---------------------------- It is understood that the several Underwriters are to make a public offering of the Firm Shares as soon as the Representatives deem it advisable to do so. The Firm Shares are to be initially offered to the public at the initial public offering price set forth in the Prospectus. The Representatives may from time to time thereafter change the public offering price and other selling terms. To the extent, if at all, that any Option Shares are purchased pursuant to Section 2 hereof, the Underwriters will offer them to the public on the foregoing terms. 10 It is further understood that you will act as the Representatives for the Underwriters in the offering and sale of the Shares in accordance with a Master Agreement Among Underwriters entered into by you and the several other Underwriters. 4. COVENANTS OF THE COMPANY AND THE SELLING STOCKHOLDERS. ----------------------------------------------------- (a) The Company covenants and agrees with the several Underwriters and each of the Selling Stockholders that: (i) The Company will (A) use its best efforts to cause the Registration Statement to become effective or, if the procedure in Rule 430A of the Rules and Regulations is followed, to prepare and timely file with the Commission under Rule 424(b) of the Rules and Regulations a Prospectus in a form approved by the Representatives containing information previously omitted at the time of effectiveness of the Registration Statement in reliance on Rule 430A of the Rules and Regulations, (B) not file any amendment to the Registration Statement or supplement to the Prospectus or document incorporated by reference therein of which the Representatives shall not previously have been advised and furnished with a copy or to which the Representatives shall have reasonably objected in writing or which is not in compliance with the Rules and Regulations, and (C) file on a timely basis all reports and any definitive proxy or information statements required to be filed by the Company with the Commission subsequent to the date of the Prospectus and prior to the termination of the offering of the Shares by the Underwriters. (ii) The Company will advise the Representatives and the Selling Stockholders promptly (A) when the Registration Statement or any post- effective amendment thereto shall have become effective, (B) of receipt of any comments from the Commission, (C) of any request of the Commission for amendment of the Registration Statement or for supplement to the Prospectus or for any additional information, and (D) of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or the use of the Prospectus or of the institution of any proceedings for that purpose. The Company will use its best efforts to prevent the issuance of any such stop order preventing or suspending the use of the Prospectus and to obtain as soon as possible the lifting thereof, if issued. (iii) The Company will cooperate with the Representatives in endeavoring to qualify the Shares for sale under the securities laws of such jurisdictions as the Representatives may reasonably have designated in writing and will make such applications, file such documents, and furnish such information as may be reasonably required for that purpose, provided the Company shall not be required to qualify as a foreign corporation or to file a general consent to service of process in any jurisdiction where it is not now so qualified or required to file such a consent. The Company will, from time to time, prepare and file such statements, reports, and other documents, as are or may be required to continue such qualifications in effect for so long a period as the Representatives may reasonably request for distribution of the Shares. 11 (iv) The Company will deliver to, or upon the order of, the Representatives, from time to time, as many copies of any Preliminary Prospectus as the Representatives may reasonably request. The Company will deliver to, or upon the order of, the Representatives during the period when delivery of a Prospectus is required under the Act, as many copies of the Prospectus in final form, or as thereafter amended or supplemented, as the Representatives may reasonably request. The Company will deliver to the Representatives at or before the Closing Date, four signed copies of the Registration Statement and all amendments thereto including all exhibits filed therewith, and will deliver to the Representatives such number of copies of the Registration Statement (including such number of copies of the exhibits filed therewith that may reasonably be requested), including documents incorporated by reference therein, and of all amendments thereto, as the Representatives may reasonably request. (v) The Company will comply with the Act and the Rules and Regulations, and the Securities Exchange Act of 1934 (the "Exchange Act"), and the rules and regulations of the Commission thereunder, so as to permit the completion of the distribution of the Shares as contemplated in this Agreement and the Prospectus. If during the period in which a prospectus is required by law to be delivered by an Underwriter or dealer, any event shall occur as a result of which, in the judgment of the Company or in the reasonable opinion of the Underwriters, it becomes necessary to amend or supplement the Prospectus in order to make the statements therein, in the light of the circumstances existing at the time the Prospectus is delivered to a purchaser, not misleading, or, if it is necessary at any time to amend or supplement the Prospectus to comply with any law, the Company promptly will either (i) prepare and file with the Commission an appropriate amendment to the Registration Statement or supplement to the Prospectus or (ii) prepare and file with the Commission an appropriate filing under the Securities Exchange Act of 1934 which shall be incorporated by reference in the Prospectus so that the Prospectus as so amended or supplemented will not, in the light of the circumstances when it is so delivered, be misleading, or so that the Prospectus will comply with the law. (vi) The Company will make generally available to its security holders, as soon as it is practicable to do so, but in any event not later than 15 months after the effective date of the Registration Statement, an earning statement (which need not be audited) in reasonable detail, covering a period of at least 12 consecutive months beginning after the effective date of the Registration Statement, which earning statement shall satisfy the requirements of Section 11(a) of the Act and Rule 158 of the Rules and Regulations and will advise you in writing when such statement has been so made available. (vii) Prior to the Closing Date, the Company will furnish to the Underwriters, as soon as they have been prepared by or are available to the Company, a copy of any unaudited interim financial statements of the Company for any period subsequent to the period covered by the most recent financial statements appearing in the Registration Statement and the Prospectus. The Company will, for a period of five years from the Closing Date, deliver to the Representatives copies of annual reports and copies of all other documents, reports and information furnished by the Company to its stockholders 12 or filed with any securities exchange pursuant to the requirements of such exchange or with the Commission pursuant to the Act or the Securities Exchange Act of 1934, as amended. The Company will deliver to the Representatives similar reports with respect to significant subsidiaries, as that term is defined in the Rules and Regulations, which are not consolidated in the Company's financial statements. (viii) No offering, sale, short sale or other disposition of any shares of Common Stock of the Company (other than shares issuable upon the exercise of currently outstanding options and warrants) or other securities convertible into or exchangeable or exerciseable for shares of Common Stock or derivative of Common Stock (or agreement for such) will be made for a period of 90 days after the date of this Agreement, directly or indirectly, by the Company otherwise than hereunder or with the prior written consent of BT Alex. Brown Incorporated. (ix) The Company will use its best efforts to list, subject to notice of issuance, the Shares on the American Stock Exchange. (x) The Company has caused each of its officers and directors, Chase Venture Capital Associates, L.P. ("CVCA") and Banque Paribas to furnish to you, on or prior to the date of this agreement, a letter or letters, in form and substance satisfactory to the Underwriters, pursuant to which each of its officers and directors and CVCA shall agree not to offer, sell, sell short or otherwise dispose of any shares of Common Stock of the Company or other capital stock of the Company, or any other securities convertible, exchangeable or exerciseable for Common Shares or derivative of Common Shares owned by such person or request the registration for the offer or sale of any of the foregoing (or as to which such person has the right to direct the disposition of), and pursuant to which Banque Paribas shall agree not to offer, sell, sell short or otherwise dispose of any shares of Common Stock of the Company underlying warrants held by Banque Paribas, for a period of 90 days after the date of this Agreement, directly or indirectly, except with the prior written consent of BT Alex. Brown Incorporated ("Lockup Agreements"). (xi) The Company shall apply the net proceeds of its sale of the Shares as set forth in the Prospectus and shall file such reports with the Commission with respect to the sale of the Shares and the application of the proceeds therefrom as may be required in accordance with Rule 463 under the Act. (xii) The Company shall not invest, or otherwise use the proceeds received by the Company from its sale of the Shares in such a manner as would require the Company or any of the Subsidiaries to register as an investment company under the Investment Company Act of 1940, as amended (the "1940 Act"). (xiii) The Company will maintain a transfer agent and, if necessary under the jurisdiction of incorporation of the Company, a registrar for the Common Stock. 13 (xiv) The Company will not take, directly or indirectly, any action designed to cause or result in, or that has constituted or might reasonably be expected to constitute, the stabilization or manipulation of the price of any securities of the Company. (xv) The Company shall adopt and implement a compliance plan that will include all material elements of an effective program to prevent and detect violations of law as identified in Commentary 3(k) to Section 8A1.2 of the federal Sentencing Guidelines. (b) Each of the Selling Stockholders covenants and agrees with the several Underwriters that: (i) No offering, sale, short sale or other disposition of any shares of Common Stock of the Company or other capital stock of the Company or other securities convertible, exchangeable or exercisable for Common Stock or derivative of Common Stock owned by the Selling Stockholder or request the registration for the offer or sale of any of the foregoing (or as to which the Selling Stockholder has the right to direct the disposition of) will be made for a period of 90 days after the date of this Agreement, directly or indirectly, by such Selling Stockholder otherwise than hereunder or with the prior written consent of BT Alex. Brown Incorporated. (ii) In order to document the Underwriters' compliance with the reporting and withholding provisions of the Tax Equity and Fiscal Responsibility Act of 1982 and the Interest and Dividend Tax Compliance Act of 1983 with respect to the transactions herein contemplated, each of the Selling Stockholders agrees to deliver to you prior to or at the Closing Date a properly completed and executed United States Treasury Department Form W-9 (or other applicable form or statement specified by Treasury Department regulations in lieu thereof). (iii) Such Selling Stockholder will not take, directly or indirectly, any action designed to cause or result in, or that has constituted or might reasonably be expected to constitute, the stabilization or manipulation of the price of any securities of the Company. 5. COSTS AND EXPENSES. ------------------ The Company will pay all costs, expenses and fees incident to the performance of the obligations of the Sellers under this Agreement, including, without limiting the generality of the foregoing, the following: accounting fees of the Company; the fees and disbursements of counsel for the Company and the Selling Stockholders; the cost of printing and delivering to, or as requested by, the Underwriters copies of the Registration Statement, Preliminary Prospectuses, the Prospectus, this Agreement, the Underwriters' Selling Memorandum, the Underwriters' Invitation Letter, the Listing Application, the Blue Sky Survey and any supplements or amendments thereto; the filing fees of the Commission; the filing fees and expenses (including reasonable legal fees and 14 disbursements) incident to securing any required review by the National Association of Securities Dealers, Inc. (the "NASD") of the terms of the sale of the Shares; the Listing Fee of the American Stock Exchange; and the expenses, including the reasonable fees and disbursements of counsel for the Underwriters, incurred in connection with the qualification of the Shares under State securities or Blue Sky laws. Any transfer taxes imposed on the sale of the shares to the several Underwriters will be paid by the Sellers pro rata. The Company agrees to pay all costs and expenses of the Underwriters including the fees and disbursements of counsel for the Underwriters incident to the offer and sale of directed shares of the Common Stock by the Underwriters to employees and persons having business relationships with the Company and its subsidiaries. The Sellers shall not, however, be required to pay for any of the Underwriters expenses (other than, in the case of the Company only, those related to qualification under NASD regulation and State securities or Blue Sky laws) except that, if this Agreement shall not be consummated because the conditions in Section 6 hereof are not satisfied, or because this Agreement is terminated by the Representatives pursuant to Section 11 hereof, or by reason of any failure, refusal or inability on the part of the Company or the Selling Stockholders to perform any undertaking or satisfy any condition of this Agreement or to comply with any of the terms hereof on their part to be performed, unless such failure to satisfy said condition or to comply with said terms be due to the default or omission of any Underwriter, then the Company shall reimburse the several Underwriters for reasonable out-of-pocket expenses, including fees and disbursements of counsel, reasonably incurred in connection with investigating, marketing and proposing to market the Shares or in contemplation of performing their obligations hereunder; but the Company and the Selling Stockholders shall not in any event be liable to any of the several Underwriters for damages on account of loss of anticipated profits from the sale by them of the Shares. 6. CONDITIONS OF OBLIGATIONS OF THE UNDERWRITERS. --------------------------------------------- The several obligations of the Underwriters to purchase the Firm Shares on the Closing Date and the Option Shares, if any, on the Option Closing Date are subject to the accuracy, as of the Closing Date or the Option Closing Date, as the case may be, of the representations and warranties of the Company and the Selling Stockholders contained herein, and to the performance by the Company and the Selling Stockholders of their covenants and obligations hereunder and to the following additional conditions: (a) The Registration Statement and all post-effective amendments thereto shall have become effective and any and all filings required by Rule 424 and Rule 430A of the Rules and Regulations shall have been made, and any request of the Commission for additional information (to be included in the Registration Statement or otherwise) shall have been disclosed to the Representatives and complied with to their reasonable satisfaction. No stop order suspending the effectiveness of the Registration Statement, as amended from time to time, shall have been issued and no proceedings for that purpose shall have been taken or, to the knowledge of the Company or the Selling Stockholders, shall be contemplated by the Commission and no injunction, restraining order, or order of 15 any nature by a Federal or state court of competent jurisdiction shall have been issued as of the Closing Date which would prevent the issuance of the Shares. (b) The Representatives shall have received on the Closing Date or the Option Closing Date, as the case may be, the opinion of Freedman, Levy, Kroll & Simonds, counsel for the Company and the Selling Stockholders, dated the Closing Date or the Option Closing Date, as the case may be, addressed to the Underwriters (and stating that it may be relied upon by counsel to the Underwriters) to the effect that: (i) The Company has been duly organized and is validly existing as a corporation in good standing under the laws of the State of Delaware, with corporate power and authority to own or lease its properties and conduct its business as described in the Registration Statement; each of the Subsidiaries has been duly organized and is validly existing as a corporation in good standing under the laws of the jurisdiction of its incorporation, with corporate power and authority to own or lease its properties and conduct its business as described in the Registration Statement; the Company and each of the Subsidiaries are duly qualified to transact business in all jurisdictions in which the conduct of their business requires such qualification, or in which the failure to qualify would have a materially adverse effect upon the business of the Company and the Subsidiaries taken as a whole; and the outstanding shares of capital stock of each of the Subsidiaries have been duly authorized and validly issued and are fully paid and non-assessable and are owned by the Company or a Subsidiary; and, to the best of such counsel's knowledge, the outstanding shares of capital stock of each of the Subsidiaries is owned free and clear of all liens, encumbrances and equities and claims, and no options, warrants or other rights to purchase, agreements or other obligations to issue or other rights to convert any obligations into any shares of capital stock or of ownership interests in the Subsidiaries are outstanding. (ii) The Company has authorized and outstanding capital stock as set forth under the caption "Capitalization" in the Prospectus; the authorized shares of the Company's Common Stock have been duly authorized; the outstanding shares of the Company's Common Stock, including the shares to be sold by the Selling Stockholders, have been duly authorized and validly issued and are fully paid and non- assessable; all of the Shares conform to the description thereof contained in the Prospectus; the certificates for the Shares, assuming they are in the form filed with the Commission, are in due and proper form; the shares of Common Stock, including the Option Shares, if any, to be sold by the Company pursuant to this Agreement have been duly authorized and will be validly issued, fully paid and non-assessable when issued and paid for as contemplated by this Agreement; and no preemptive rights of stockholders exist with respect to any of the Shares or the issue or sale thereof. (iii) Except as described in or contemplated by the Prospectus, to the knowledge of such counsel, there are no outstanding securities of the Company 16 convertible or exchangeable into or evidencing the right to purchase or subscribe for any shares of capital stock of the Company and there are no outstanding or authorized options, warrants or rights of any character obligating the Company to issue any shares of its capital stock or any securities convertible or exchangeable into or evidencing the right to purchase or subscribe for any shares of such stock; and except as described in the Prospectus, to the knowledge of such counsel, no holder of any securities of the Company or any other person has the right, contractual or otherwise, which has not been satisfied or effectively waived, to cause the Company to sell or otherwise issue to them, or to permit them to underwrite the sale of, any of the Shares or the right to have any Common Shares or other securities of the Company included in the Registration Statement or the right, as a result of the filing of the Registration Statement, to require registration under the Act of any shares of Common Stock or other securities of the Company. (iv) The Registration Statement has become effective under the Act and, to the best of the knowledge of such counsel, no stop order proceedings with respect thereto have been instituted or are pending or threatened under the Act. (v) The Registration Statement, the Prospectus and each amendment or supplement thereto and documents incorporated by reference therein comply as to form in all material respects with the requirements of the Act or the Securities Exchange Act of 1934, as applicable and the applicable rules and regulations thereunder (except that such counsel need express no opinion as to the financial statements and related schedules or material incorporated by reference therein). Form S-3 is available for use by the Company. (vi) The statements under the caption "Risk Factors -- Shares Eligible for Future Sale" in the Prospectus, insofar as such statements constitute a summary of documents referred to therein or matters of law, fairly summarize in all material respects the information called for with respect to such documents and matters. (vii) Such counsel does not know of any contracts or documents required to be filed as exhibits to or incorporated by reference in the Registration Statement or described in the Registration Statement or the Prospectus which are no so filed, incorporated by reference or described as required, and such contracts and documents as are summarized in the Registration Statement or the Prospectus are fairly summarized in all material respects. (viii) Such counsel knows of no material legal or governmental proceedings pending or threatened against the Company or any of the Subsidiaries except as set forth in the Prospectus. (ix) The execution and delivery of this Agreement and the consummation of the transactions herein contemplated do not and will not conflict with or result in a breach of any of the terms or provisions of, or constitute a default under, the 17 Charter or By-Laws of the Company, or any agreement or instrument known to such counsel to which the Company or any of the Subsidiaries is a party or by which the Company or any of the Subsidiaries may be bound. (x) This Agreement has been duly authorized, executed and delivered by the Company. (xi) No approval, consent, order, authorization, designation, declaration or filing by or with any regulatory, administrative or other governmental body is necessary in connection with the execution and delivery of this Agreement and the consummation of the transactions herein contemplated (other than as may be required by the NASD or as required by State securities and Blue Sky laws as to which such counsel need express no opinion) except such as have been obtained or made, specifying the same. (xii) The Company is not, and will not become, as a result of the consummation of the transactions contemplated by this Agreement, and application of the net proceeds therefrom as described in the Prospectus, required to register as an investment company under the 1940 Act. (xiii) This Agreement has been duly authorized, executed and delivered on behalf of the Selling Stockholders. (xiv) Each Selling Stockholder has full legal right, power and authority, and any approval required by law (other than as required by the National Association of Securities Dealers, Inc., or by State securities and Blue Sky laws as to which such counsel need express no opinion), to sell, assign, transfer and deliver the portion of the Shares to be sold by such Selling Stockholder. (xv) The Custody Agreement and the Power of Attorney executed and delivered by each Selling Stockholder is valid and binding. (xvi) The Underwriters (assuming that they are bona fide purchasers within the meaning of the Uniform Commercial Code) have acquired good and valid title to the Shares being sold by each Selling Stockholder on the Closing Date, free and clear of all liens, encumbrances, equities and claims. In rendering such opinion Freedman, Levy, Kroll & Simonds may rely as to matters governed by the laws of States other than Delaware or Maryland or the District of Columbia or Federal laws on local counsel in such jurisdictions and, as to matters set forth in subparagraphs (xiii), (xiv) and (xv), on opinions of other counsel representing the respective Selling Stockholder, provided that in each case Freedman, Levy, Kroll & Simonds shall state that they believe that they and the Underwriters are justified in relying on such other counsel. In addition to the matters set forth above, such opinion shall also include a statement to the effect that nothing has come to the attention of such 18 counsel which leads them to believe that (i) the Registration Statement, at the time it became effective under the Act (but after giving effect to any modifications incorporated therein pursuant to Rule 430A under the Act) and as of the Closing Date or the Option Closing Date, as the case may be, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, and (ii) the Prospectus, or any supplement thereto, on the date it was filed pursuant to the Rules and Regulations and as of the Closing Date or the Option Closing Date, as the case may be, contained an untrue statement of a material fact or omitted to state a material fact necessary in order to make the statements, in the light of the circumstances under which they are made, not misleading (except that such counsel need express no view as to financial statements and schedules and other financial and statistical information included or incorporated therein). With respect to such statement, Freedman, Levy, Kroll & Simonds may state that their belief is based upon the procedures set forth therein, but is without independent check and verification. (c) The Representatives shall have received from Hogan & Hartson L.L.P., counsel for the Underwriters, an opinion dated the Closing Date or the Option Closing Date, as the case may be, substantially to the effect specified in subparagraphs (ii), (iii), (iv) and (x) of Paragraph (b) of this Section 6, and that the Company is a duly organized and validly existing corporation under the laws of the State of Delaware. In rendering such opinion Hogan & Hartson L.L.P. may rely as to all matters governed other than by the laws of the States of Delaware or Maryland or the District of Columbia or Federal laws on the opinion of counsel referred to in Paragraph (b) of this Section 6. In addition to the matters set forth above, such opinion shall also include a statement to the effect that nothing has come to the attention of such counsel which leads them to believe that (i) the Registration Statement, or any amendment thereto, as of the time it became effective under the Act (but after giving effect to any modifications incorporated therein pursuant to Rule 430A under the Act) as of the Closing Date or the Option Closing Date, as the case may be, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, and (ii) the Prospectus, or any supplement thereto, on the date it was filed pursuant to the Rules and Regulations and as of the Closing Date or the Option Closing Date, as the case may be, contained an untrue statement of a material fact or omitted to state a material fact, necessary in order to make the statements, in the light of the circumstances under which they are made, not misleading (except that such counsel need express no view as to financial statements and schedules and other financial and statistical information included or incorporated therein). With respect to such statement, Hogan & Hartson L.L.P. may state that their belief is based upon the procedures set forth therein, but is without independent check and verification. (d) The Representatives shall have received, on each of the dates hereof, the Closing Date and the Option Closing Date, as the case may be, a letter dated the date hereof, the Closing Date or the Option Closing Date, as the case may be, in form and substance satisfactory to you, of Coopers & Lybrand L.L.P. confirming that they are independent public accountants within the meaning of the Act and the applicable 19 published Rules and Regulations thereunder and stating that in their opinion the financial statements and schedules examined by them and included in the Registration Statement comply in form in all material respects with the applicable accounting requirements of the Act and the related published Rules and Regulations; and containing such other statements and information as is ordinarily included in accountants' "comfort letters" to Underwriters with respect to the financial statements and certain financial and statistical information contained in the Registration Statement and Prospectus. (e) The Representatives shall have received on the Closing Date or the Option Closing Date, as the case may be, a certificate or certificates of the Chief Executive Officer and the Chief Financial Officer of the Company to the effect that, as of the Closing Date or the Option Closing Date, as the case may be, each of them severally represents as follows: (i) The Registration Statement has become effective under the Act and no stop order suspending the effectiveness of the Registration Statement has been issued, and no proceedings for such purpose have been taken or are, to his knowledge, contemplated by the Commission; (ii) The representations and warranties of the Company contained in Section 1 hereof are true and correct as of the Closing Date or the Option Closing Date, as the case may be; (iii) All filings required to have been made pursuant to Rules 424 or 430A under the Act have been made; (iv) He has carefully examined the Registration Statement and the Prospectus and, in his opinion, as of the effective date of the Registration Statement, the statements contained in the Registration Statement were true and correct, and such Registration Statement and Prospectus did not omit to state a material fact required to be stated therein or necessary in order to make the statements therein not misleading, and since the effective date of the Registration Statement, no event has occurred which should have been set forth in a supplement to or an amendment of the Prospectus which has not been so set forth in such supplement or amendment; and (v) Since the respective dates as of which information is given in the Registration Statement and Prospectus, there has not been any material adverse change or any development involving a prospective material adverse change in or affecting the condition, financial or otherwise, of the Company and its Subsidiaries taken as a whole or the earnings, business, management, properties, assets, rights, operations, condition (financial or otherwise) or prospects of the Company and the Subsidiaries taken as a whole, whether or not arising in the ordinary course of business. 20 (f) The Company and the Selling Stockholders shall have furnished to the Representatives such further certificates and documents confirming the representations and warranties, covenants and conditions contained herein and related matters as the Representatives may reasonably have requested. (g) The Firm Shares and Option Shares, if any, have been approved for listing upon notice of issuance on the American Stock Exchange. (h) The Lockup Agreements described in Section 4(a)(x) are in full force and effect. The opinions and certificates mentioned in this Agreement shall be deemed to be in compliance with the provisions hereof only if they are in all material respects satisfactory to the Representatives and to Hogan & Hartson L.L.P., counsel for the Underwriters. If any of the conditions hereinabove provided for in this Section 6 shall not have been fulfilled when and as required by this Agreement to be fulfilled, the obligations of the Underwriters hereunder may be terminated by the Representatives by notifying the Company and the Selling Stockholders of such termination in writing or by telegram at or prior to the Closing Date or the Option Closing Date, as the case may be. In such event, the Company, the Selling Stockholders and the Underwriters shall not be under any obligation to each other (except to the extent provided in Sections 5 and 8 hereof). 7. CONDITIONS OF THE OBLIGATIONS OF THE SELLERS. -------------------------------------------- The obligations of the Sellers to sell and deliver the portion of the Shares required to be delivered as and when specified in this Agreement are subject to the conditions that at the Closing Date or the Option Closing Date, as the case may be, no stop order suspending the effectiveness of the Registration Statement shall have been issued and in effect or proceedings therefor initiated or threatened. 8. INDEMNIFICATION. --------------- (a) The Company agrees to indemnify and hold harmless, and Ivan R. Sabel and Richard A. Stein (the "Management Stockholders") agree to indemnify and hold harmless, each Underwriter and each person, if any, who controls any Underwriter within the meaning of the Act, against any losses, claims, damages or liabilities to which such Underwriter or any such controlling person may become subject under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions or proceedings in respect thereof) arise out of or are based upon (i) any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement, any Preliminary Prospectus, the Prospectus or any amendment or supplement thereto, (ii) the 21 omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in the light of the circumstances under which they were made, or (iii) any oral untrue statement or alleged untrue statement of any material fact referred to in clause (i) or (ii) above by any Underwriter in connection with the offering contemplated hereby (provided, that the Company and the Management Stockholders shall not be liable under this clause (iii) to the extent that it is determined in a final judgment by a court of competent jurisdiction that such loss, claim, damage, liability or action resulted directly from any such acts or failures to act undertaken or omitted to be taken by such Underwriter through its gross negligence or willful misconduct); and will reimburse each Underwriter and each such controlling person upon demand for any legal or other expenses reasonably incurred by such Underwriter or such controlling person in connection with investigating or defending any such loss, claim, damage or liability, action or proceeding or in responding to a subpoena or governmental inquiry related to the offering of the Shares, whether or not such Underwriter or controlling person is a party to any action or proceeding; provided, however, that the Company and the Management Stockholders will not be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement, or omission or alleged omission made in the Registration Statement, any Preliminary Prospectus, the Prospectus, or such amendment or supplement, in reliance upon and in conformity with written information furnished to the Company by or through the Representatives specifically for use in the preparation thereof. Notwithstanding the foregoing, the obligations of the Management Stockholders to indemnify pursuant to this Section 8 shall not, in the case of each Management Stockholder, exceed the amount of offering proceeds received by such Management Stockholder as a Selling Stockholder. This indemnity agreement will be in addition to any liability which the Company or the Management Stockholders may otherwise have. (b) CVCA agrees to indemnify and hold harmless each Underwriter and each person, if any, who controls any Underwriter within the meaning of the Act to the same extent as the foregoing indemnity of the Company to the Underwriters, but only with reference to information relating to CVCA included or incorporated by reference in the Registration Statement, any Preliminary Prospectus, the Prospectus or any amendment of supplement thereto. (c) Each Underwriter agrees severally and not jointly to indemnify and hold harmless the Company, each of its directors, each of its officers who have signed the Registration Statement, the Selling Stockholders and each person, if any, who controls the Company or the Selling Stockholders within the meaning of the Act, against any losses, claims, damages or liabilities to which the Company or any such director, officer, Selling Stockholder or controlling person may become subject under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions or proceedings in respect thereof) arise out of or are based upon (i) any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement, any Preliminary Prospectus, the Prospectus or any amendment or supplement thereto, or 22 (ii) the omission or the alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances under which they were made; and will reimburse any legal or other expenses reasonably incurred by the Company or any such director, officer, Selling Stockholder or controlling person in connection with investigating or defending any such loss, claim, damage, liability, action or proceeding; provided, however, that each Underwriter will be liable in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission has been made in the Registration Statement, any Preliminary Prospectus, the Prospectus or such amendment or supplement, in reliance upon and in conformity with written information furnished to the Company by or through the Representatives specifically for use in the preparation thereof. This indemnity agreement will be in addition to any liability which such Underwriter may otherwise have. (d) In case any proceeding (including any governmental investigation) shall be instituted involving any person in respect of which indemnity may be sought pursuant to this Section 8, such person (the "indemnified party") shall promptly notify the person against whom such indemnity may be sought (the "indemnifying party") in writing. No indemnification provided for in Section 8(a), (b) or (c) shall be available to any party who shall fail to give notice as provided in this Section 8(d) if the party to whom notice was not given was unaware of the proceeding to which such notice would have related and was materially prejudiced by the failure to give such notice, but the failure to give such notice shall not relieve the indemnifying party or parties from any liability which it or they may have to the indemnified party for contribution or otherwise than on account of the provisions of Section 8(a), (b) or (c). In case any such proceeding shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate therein and, to the extent that it shall wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel satisfactory to such indemnified party and shall pay as incurred (or within 30 days of presentation) the fees and disbursements of such counsel related to such proceeding. In any such proceeding, any indemnified party shall have the right to retain its own counsel at its own expense. Notwithstanding the foregoing, the indemnifying party shall pay as incurred the fees and expenses of the counsel retained by the indemnified party in the event (i) the indemnifying party and the indemnified party shall have mutually agreed to the retention of such counsel, (ii) the named parties to any such proceeding (including any impleaded parties) include both the indemnifying party and the indemnified party and representation of both parties by the same counsel would be inappropriate due to actual or potential differing interests between them or (iii) the indemnifying party shall have failed to assume the defense and employ counsel acceptable to the indemnified party within a reasonable period of time after notice of commencement of the action. It is understood that the indemnifying party shall not, in connection with any proceeding or related proceedings in the same jurisdiction, be liable for the reasonable fees and expenses of more than one separate firm for all such indemnified parties. Such firm shall be designated in writing by you in the case of parties indemnified pursuant to Section 8(a) 23 and 8(b) and by the Company in the case of parties indemnified pursuant to Section 8(c). The indemnifying party shall not be liable for any settlement of any proceeding effected without its written consent but if settled with such consent or if there be a final judgment for the plaintiff, the indemnifying party agrees to indemnify the indemnified party from and against any loss or liability by reason of such settlement or judgment. In addition, the indemnifying party will not, without the prior written consent of the indemnified party, settle or compromise or consent to the entry of any judgment in any pending or threatened claim, action or proceeding of which indemnification may be sought hereunder (whether or not any indemnified party is an actual or potential party to such claim, action or proceeding) unless such settlement, compromise or consent includes an unconditional release of each indemnified party from all liability arising out of such claim, action or proceeding. (e) If the indemnification provided for in this Section 8 is unavailable to or insufficient to hold harmless an indemnified party under Section 8(a), (b) or (c) above in respect of any losses, claims, damages or liabilities (or actions or proceedings in respect thereof) referred to therein, then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (or actions or proceedings in respect thereof) in such proportion as is appropriate to reflect the relative benefits received by the Sellers and the Underwriters from the offering of the Shares. If, however, the allocation provided by the immediately preceding sentence is not permitted by applicable law then each indemnifying party shall contribute to such amount paid or payable by such indemnified party in such proportion as is appropriate to reflect not only such relative benefits but also the relative fault of the Company and the Selling Stockholders on the one hand and the Underwriters on the other in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities, (or actions or proceedings in respect thereof), as well as any other relevant equitable considerations. The relative benefits received by the Company, the Selling Stockholders and the Underwriters shall be deemed to be in the same respective proportions as the total net proceeds from the offering (before deducting expenses) received by each of the Company and the Selling Stockholders and the total underwriting discounts and commissions received by the Underwriters, in each case as set forth in the table on the cover page of the Prospectus, bear to the aggregate public offering price of the Shares. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company and the Selling Stockholders on the one hand or the Underwriters on the other and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company, the Selling Stockholders and the Underwriters agree that it would not be just and equitable if contributions pursuant to this Section 8(e) were determined by pro rata allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to above in this Section 8(e). The amount paid or payable by an 24 indemnified party as a result of the losses, claims, damages or liabilities (or actions or proceedings in respect thereof) referred to above in this Section 8(e) shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this subsection (e), (i) no Underwriter shall be required to contribute any amount in excess of the underwriting discounts and commissions applicable to the Shares purchased by such Underwriter, and (ii) no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations in this Section 8(e) to contribute are several in proportion to their respective underwriting obligations and not joint. (f) In any proceeding relating to the Registration Statement, any Preliminary Prospectus, the Prospectus or any supplement or amendment thereto, each party against whom contribution may be sought under this Section 8 hereby consents to the jurisdiction of any court having jurisdiction over any other contributing party, agrees that process issuing from such court may be served upon him or it by any other contributing party and consents to the service of such process and agrees that any other contributing party may join him or it as an additional defendant in any such proceeding in which such other contributing party is a party. (g) Any losses, claims, damages, liabilities or expenses for which an indemnified party is entitled to indemnification or contribution under this Section 8 shall be paid by the indemnifying party to the indemnified party as such losses, claims, damages, liabilities or expenses are incurred. The indemnity and contribution agreements contained in this Section 8 and the representations and warranties of the Company set forth in this Agreement shall remain operative and in full force and effect, regardless of (i) any investigation made by or on behalf of any Underwriter or any person controlling any Underwriter, the Company, its directors or officers or any persons controlling the Company, (ii) acceptance of any Shares and payment therefor hereunder, and (iii) any termination of this Agreement. A successor to any Underwriter, or to the Company, its directors or officers, or any person controlling the Company, shall be entitled to the benefits of the indemnity, contribution and reimbursement agreements contained in this Section 8. (h) Notwithstanding anything to the contrary contained in this Agreement, the provisions of the Registration Agreement dated as of May 15, 1989 shall govern rights to indemnification and contribution as between the Company and the Selling Stockholders, provided that the provisions of such Registration Agreement shall have no impact whatsoever on the rights of the Underwriters to indemnification under this Agreement. 9. DEFAULT BY UNDERWRITERS. ----------------------- If on the Closing Date or the Option Closing Date, as the case may be, any Underwriter shall fail to purchase and pay for the portion of the Shares which such 25 Underwriter has agreed to purchase and pay for on such date (otherwise than by reason of any default on the part of the Company or a Selling Stockholder), you, as Representatives of the Underwriters, shall use your reasonable efforts to procure within 36 hours thereafter one or more of the other Underwriters, or any others, to purchase from the Company and the Selling Stockholders such amounts as may be agreed upon and upon the terms set forth herein, the Firm Shares or Option Shares, as the case may be, which the defaulting Underwriter or Underwriters failed to purchase. If during such 36 hours you, as such Representatives, shall not have procured such other Underwriters, or any others, to purchase the Firm Shares or Option Shares, as the case may be, agreed to be purchased by the defaulting Underwriter or Underwriters, then (a) if the aggregate number of shares with respect to which such default shall occur does not exceed 10% of the Firm Shares or Option Shares, as the case may be, covered hereby, the other Underwriters shall be obligated, severally, in proportion to the respective numbers of Firm Shares or Option Shares, as the case may be, which they are obligated to purchase hereunder, to purchase the Firm Shares or Option Shares, as the case may be, which such defaulting Underwriter or Underwriters failed to purchase, or (b) if the aggregate number of shares of Firm Shares or Option Shares, as the case may be, with respect to which such default shall occur exceeds 10% of the Firm Shares or Option Shares, as the case may be, covered hereby, the Company and the Selling Stockholders or you as the Representatives of the Underwriters will have the right, by written notice given within the next 36-hour period to the parties to this Agreement, to terminate this Agreement without liability on the part of the non-defaulting Underwriters or of the Company or of the Selling Stockholders except to the extent provided in Section 8 hereof. In the event of a default by any Underwriter or Underwriters, as set forth in this Section 9, the Closing Date or Option Closing Date, as the case may be, may be postponed for such period, not exceeding seven days, as you, as Representatives, may determine in order that the required changes in the Registration Statement or in the Prospectus or in any other documents or arrangements may be effected. The term "Underwriter" includes any person substituted for a defaulting Underwriter. Any action taken under this Section 9 shall not relieve any defaulting Underwriter from liability in respect of any default of such Underwriter under this Agreement. 10. NOTICES. ------- All communications hereunder shall be in writing and, except as otherwise provided herein, will be mailed, delivered, telecopied or telegraphed and confirmed as follows: if to the Underwriters, to BT Alex. Brown Incorporated, One South Street, Baltimore, Maryland 21202, Attention: Steven R. Schuh; with a copy to BT Alex. Brown Incorporated, One South Street, Baltimore, Maryland 21202. Attention: General Counsel; if to the Company or to the Selling Stockholders, to Ivan R. Sabel, Chief Executive Officer, Hanger Orthopedic Group, Inc., 7700 Old Georgetown Road, Second Floor, Bethesda, Maryland 20814. 26 11. TERMINATION. ----------- This Agreement may be terminated by you by notice to the Sellers as follows: (a) at any time prior to the earlier of (i) the time the Shares are released by you for sale by notice to the Underwriters, or (ii) 11:30 a.m. on the first business day following the date of this Agreement; (b) at any time prior to the Closing Date if any of the following has occurred: (i) since the respective dates as of which information is given in the Registration Statement and the Prospectus, any material adverse change or any development involving a prospective material adverse change in or affecting the condition, financial or otherwise, of the Company and its Subsidiaries taken as a whole or the earnings, business, management, properties, assets, rights, operations, condition (financial or otherwise) or prospects of the Company and its Subsidiaries taken as a whole, whether or not arising in the ordinary course of business, (ii) any outbreak or escalation of hostilities or declaration of war or national emergency or other national or international calamity or crisis or change in economic or political conditions if the effect of such outbreak, escalation, declaration, emergency, calamity, crisis or change on the financial markets of the United States would, in your reasonable judgment, make it impracticable to market the Shares or to enforce contracts for the sale of the Shares, or (iii) suspension of trading in securities generally on the New York Stock Exchange or the American Stock Exchange or limitation on prices (other than limitations on hours or numbers of days of trading) for securities on either such Exchange, (iv) the enactment, publication, decree or other promulgation of any statute, regulation, rule or order of any court or other governmental authority which in your opinion materially and adversely affects or may materially and adversely affect the business or operations of the Company, (v) declaration of a banking moratorium by United States or New York State authorities, (vi) the suspension of trading of the Company's common stock by the Commission on the American Stock Exchange or (vii) the taking of any action by any governmental body or agency in respect of its monetary or fiscal affairs which in your reasonable opinion has a material adverse effect on the securities markets in the United States; or (c) as provided in Sections 6 and 9 of this Agreement. 12. SUCCESSORS. ---------- This Agreement has been and is made solely for the benefit of the Underwriters, the Company and the Selling Stockholders and their respective successors, executors, administrators, heirs and assigns, and the officers, directors and controlling persons referred to herein, and no other person will have any right or obligation hereunder. No purchaser of any of the Shares from any Underwriter shall be deemed a successor or assign merely because of such purchase. 27 13. INFORMATION PROVIDED BY UNDERWRITERS. ------------------------------------ The Company, the Selling Stockholders and the Underwriters acknowledge and agree that the only information furnished or to be furnished by any Underwriter to the Company for inclusion in any Prospectus or the Registration Statement consists of the information set forth in the last paragraph on the front cover page (insofar as such information relates to the Underwriters), legends required by Item 502(d) of Regulation S-K under the Act and the information contained under the caption "Underwriting" in the Prospectus. 14. MISCELLANEOUS. ------------- The reimbursement, indemnification and contribution agreements contained in this Agreement and the representations, warranties and covenants in this Agreement shall remain in full force and effect regardless of (a) any termination of this Agreement, (b) any investigation made by or on behalf of any Underwriter or controlling person thereof, or by or on behalf of the Company or its directors or officers and (c) delivery of and payment for the Shares under this Agreement. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. This Agreement shall be governed by, and construed in accordance with, the laws of the State of Maryland. If the foregoing letter is in accordance with your understanding of our agreement, please sign and return to us the enclosed duplicates hereof, whereupon it will become a binding agreement among the Company, the Selling Stockholders and the several Underwriters in accordance with its terms. Any person executing and delivering this Agreement as Attorney-in-Fact for a Selling Stockholder represents by so doing that he has been duly appointed as Attorney-in-Fact by such Selling Stockholder pursuant to a validly existing and binding Power of Attorney which authorizes such Attorney-in-Fact to take such action. Very truly yours, HANGER ORTHOPEDIC GROUP, INC. By: _______________________________________ Selling Stockholders listed on Schedule II 28 By: _______________________________________ Attorney-in-Fact The foregoing Underwriting Agreement is hereby confirmed and accepted as of the date first above written. BT ALEX. BROWN INCORPORATED NATIONSBANC MONTGOMERY SECURITIES LLC LEGG MASON WOOD WALKER, INCORPORATED As Representatives of the several Underwriters listed on Schedule I By: BT Alex. Brown Incorporated By: __________________________________________ Authorized Officer __________________________________________ 29 SCHEDULE I Schedule of Underwriters
Number of Firm Shares to be Underwriter Purchased
SCHEDULE II Schedule of Selling Stockholders Number of Firm Shares Selling Stockholder to be Sold ------------------- --------------------- __________ Total __________ EXHIBIT A Subsidiaries Apothecaries, Inc. Columbia Brace Acquisition Corp. DOBI-Symplex, Inc. Hanger Europe, N.V. Hanger Prosthetics & Orthotics, Inc. Metzgers Orthopaedic Services, Inc. OPNET, Inc. Rehabilitation Engineering, Inc. Southern Prosthetic Supply, Inc. EX-5 3 EXHIBIT 5 - LEGAL OPINION EXHIBIT 5 June 11, 1998 Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 Re: Hanger Orthopedic Group, Inc. Registration Statement on Form S-3 Gentlemen: We are counsel to Hanger Orthopedic Group, Inc. (the "Company") and have represented the Company in connection with the Registration Statement on Form S-3 being filed by it today with the Commission (together with all exhibits thereto, the "Registration Statement"). The Registration Statement relates to an underwritten public offering of up to 3,795,000 shares of the Company's common stock, par value of $.01 per share, (the "Shares") to be made through a group of underwriters represented by BT Alex. Brown Incorporated, NationsBanc Montgomery Securities LLC and Legg Mason Wood Walker, Incorporated. Such amount includes 2,400,000 Shares being offered by the Company, 900,000 Shares being offered by certain shareholders of the Company and 495,000 Shares underlying an over-allotment option to be granted to the underwriters. A form of underwriting agreement is filed as Exhibit 1 to the Registration Statement (the "Underwriting Agreement"). This opinion is being delivered to the Commission as Exhibit 5 to the Registration Statement. We have examined (1) the Articles of Incorporation, and all amendments thereto, certified by the Secretary of State of the State of Delaware, (2) the By-Laws of the Company, certified by the Secretary of the Company as being those currently in effect, (3) the Registration Statement, and (4) such other corporate records, certificates, documents and other instruments as in our opinion are necessary or appropriate in connection with expressing the opinions set forth below. Based upon the foregoing, it is our opinion that: 1. The Company is a corporation duly organized and validly existing under the laws of the State of Delaware. 2. When the Shares shall have been paid for and issued in accordance with the terms of the Underwriting Agreement and as provided in the Registration Statement, the Shares thus sold will be legally issued, fully paid and non-assessable. This firm hereby consents to the reference to it under the heading "Legal Matters" appearing in the Prospectus which is part of the Registration Statement. Sincerely, Freedman, Levy, Kroll & Simonds EX-23.B 4 EXHIBIT 23B - CONSENT OF COOPERS & LYBRAND EXHIBIT 23(B) CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the inclusion in and incorporation by reference in this Registration Statement on Form S-3 of our report, dated March 13, 1998, on our audits of the consolidated financial statements and financial statement schedule of Hanger Orthopedic Group, Inc. as of December 31, 1996 and 1997, and for the years ended December 31, 1995, 1996 and 1997, which report is both included and incorporated by reference in this Registration Statement. We also consent to the reference to our firm under the caption "Experts." COOPERS & LYBRAND L.L.P. Philadelphia, Pennsylvania June 11, 1998 -----END PRIVACY-ENHANCED MESSAGE-----