FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 29, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number: 0-26538
Encore Medical Corporation
(Exact name of Registrant as specified in its charter)
Delaware 65-0572565
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9800 Metric Boulevard
Austin, Texas 78758
(Address of principal executive offices) (Zip code)
512-832-9500
(Registrant's telephone number including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
---
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date.
Title Outstanding
Common Stock 9,026,085
Part I. Financial Information
Item 1. Financial Statements
Encore Medical Corporation and Subsidiaries
Consolidated Balance Sheets
As of September 29, 2000 and December 31, 1999
(in thousands, except share data)
(unaudited)
September 29, December 31,
2000 1999
------- -------
Assets
Cash $ 1 $ 1
Accounts receivable, net 5,015 4,454
Inventories, net 23,715 19,090
Prepaid expenses and other current assets 883 929
------- -------
Total current assets 29,614 24,474
Property, plant and equipment, net 5,723 6,218
Goodwill, net 4,898 5,396
Other non current assets 766 827
------- -------
Total assets $41,001 $36,915
======= =======
Liabilities and Stockholders' Equity
Current portion - long-term debt $ 675 $ 734
Accounts payable and accrued expenses 3,115 3,060
------- -------
Total current liabilities 3,790 3,794
Long-term debt, net of current portion 15,166 12,047
------- -------
Total liabilities 18,956 15,841
------- -------
Common stock, $0.001 par value, 35,000,000 shares
authorized, 9,348,000 and 9,340,000 shares issued 9 9
Additional paid-in capital 19,453 19,379
Deferred compensation (233) (288)
Retained earnings 4,237 3,275
Less cost of repurchased stock, warrants, and rights
(322,000 and 278,000 shares, respectively) (1,421) (1,301)
------- -------
Total stockholders' equity 22,045 21,074
------- -------
Total liabilities and stockholders' equity $41,001 $36,915
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
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Encore Medical Corporation and Subsidiaries
Consolidated Statements of Income
For the three months and nine months ended September 29, 2000 and October 1,
1999
(in thousands, except share data)
(unaudited)
Three Months Ended Nine Months Ended
--------------------- -----------------------
September 29, October 1, September 29, October 1,
2000 1999 2000 1999
---- ---- ---- ----
Sales $ 6,993 $ 6,235 $ 22,689 $ 19,728
Cost of goods sold 2,531 1,955 7,932 6,267
---------- ----------- ---------- -----------
Gross margin 4,462 4,280 14,757 13,461
Operating expenses:
Research and development 420 412 1,340 1,190
Selling, general and administrative 3,402 3,135 11,295 9,863
---------- ----------- ---------- -----------
Operating income 640 733 2,122 2,408
Interest expense (349) (275) (962) (689)
Other income 146 109 298 221
---------- ----------- ---------- -----------
Income before income taxes 437 567 1,458 1,940
Current provision for income taxes 149 188 496 642
---------- ----------- ---------- -----------
Net income $ 288 $ 379 $ 962 $ 1,298
========== =========== ========== ===========
Basic earnings per share $0.03 $0.04 $0.11 $0.14
Shares used in computing basic earnings
per share 8,996,000 9,139,000 8,989,000 9,115,000
Diluted earnings per share $0.03 $0.04 $0.10 $0.13
Shares used in computing diluted
earnings 9,697,000 10,196,000 9,932,000 10,313,000
per share
The accompanying notes are an integral part of the consolidated financial
statements.
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Encore Medical Corporation and Subsidiaries
Consolidated Statements of Cash Flow
For the nine months ended September 29, 2000 and October 1, 1999
(in thousands)
(unaudited)
Nine Months Ended
September 29, October 1,
2000 1999
---- ----
Cash flows from operating activities:
Net income $ 962 $ 1,298
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 2,218 1,954
Loss on disposal of equipment 57 0
Other 0 (1)
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable (561) 494
Increase in inventories (4,625) (1,971)
Decrease (increase) in prepaid expenses and other assets 241 (1,076)
Increase (decrease) in accounts payable and accrued expense 17 (1,873)
------- -------
Net cash used in operating activities (1,691) (1,175)
------- -------
Cash flows from investing activities:
Acquisition of Biodynamic Technologies, Inc. 0 (1,088)
Purchases of property and equipment (1,263) (1,549)
------- -------
Net cash used in investing activities (1,263) (2,637)
------- -------
Cash flows from financing activities:
Proceeds from issuance of stock 13 101
Payments to acquire treasury stock (119) (474)
Proceeds from issuance of treasury stock 0 20
Payments on payable to a related party 0 (800)
Payments on long-term debt (570) (481)
Proceeds from long-term debt 3,630 5,446
------- -------
Net cash provided by financing activities 2,954 3,812
------- -------
Net (decrease) increase in cash equivalents 0 0
Cash and cash equivalents at beginning of period 1 1
------- -------
Cash and cash equivalents at end of period $ 1 $ 1
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
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Encore Medical Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
Encore Medical Corporation, a Delaware corporation, and its wholly owned
subsidiaries (individually and collectively referred to as the "Company"). All
significant intercompany balances and transactions have been eliminated in
consolidation. The unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
notes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and nine month periods ended
September 29, 2000 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2000. For further information, refer
to the consolidated financial statements and footnotes thereto included in the
Company's Form 10-K dated December 31, 1999 (the "Form 10-K").
2. DESCRIPTION OF BUSINESS
The Company, through its primary operating subsidiary, Encore Orthopedics,
Inc. ("Encore"), designs, manufactures, markets and sells products for the
orthopedic implant industry primarily in the United States, Europe and Asia.
The Company's products are subject to regulation by the Food and Drug
Administration ("FDA") with respect to their sale in the United States, and the
Company must obtain FDA authorization to market each of its products before it
can be sold in the United States. Additionally, the Company is subject to
similar regulations in many of the international countries in which it sells
products.
3. ACQUISITION OF BIODYNAMIC TECHNOLOGIES, INC.
On March 30, 1999, the Company and Biodynamic Technologies, Inc. ("BTI")
executed a stock purchase agreement whereby the Company purchased substantially
all of the outstanding stock of BTI in exchange for cash and promissory notes
payable to the former shareholders of BTI. This acquisition has been accounted
for as a purchase and, accordingly, the net assets of BTI at March 30, 1999 have
been consolidated into the accompanying financial statements. The terms of the
agreement require a total cash payment of $1,068,000 and notes payable in an
aggregate amount of $3,166,000. For financial purposes, $140,000 of the purchase
price was treated as purchased technology, which is being amortized over seven
years, and $4,190,000 was treated as goodwill, which is being amortized over 15
years.
4. INVENTORIES
Inventories at September 29, 2000 and December 31, 1999 are as follows (in
thousands):
September 29, December 31,
2000 1999
------- -------
Components and raw materials $ 4,866 $ 3,953
Work in process 2,824 1,097
Finished goods 16,730 14,811
------- -------
24,420 19,861
Less-reserve for obsolescence (705) (771)
------- -------
$23,715 $19,090
======= =======
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5. NET INCOME PER SHARE
Basic earnings per share ("EPS") is computed by dividing net income by the
weighted average number of common shares outstanding during each period. Diluted
EPS is computed by dividing net income by the weighted average number of common
shares and common share equivalents outstanding (if dilutive) during each
period. Common share equivalents include stock options and warrants. The number
of common share equivalents outstanding relating to stock options and warrants
is computed using the treasury stock method.
The reconciliation of the denominators used to calculate the basic and
diluted earnings per share for the periods ended September 29, 2000 and October
1, 1999, respectively, are as follows (in thousands):
Three Months Ended Nine Months Ended
--------------------------- -------------------------------
September 29, October 1, September 29, October 1,
2000 1999 2000 1999
----- ------ ----- ------
Weighted average shares outstanding 8,996 9,139 8,989 9,115
Plus: Common stock equivalents 701 1,057 943 1,198
----- ------ ----- ------
Weighted average shares outstanding-diluted 9,697 10,196 9,932 10,313
===== ====== ===== ======
The company has excluded certain stock options and warrants from the
calculation of diluted earnings per share because their exercise price was
greater than the average market price of the common shares. The total number of
common stock equivalents excluded from the calculations of diluted earnings per
common share were 6,781,274 and 6,528,778 for the three months ended September
29, 2000 and October 1, 1999, respectively, and 6,441,277 and 6,221,693 for the
nine months ended September 29, 2000 and October 1, 1999, respectively.
6. SEGMENT INFORMATION
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which the
Company adopted in the first quarter of 1998, which uses the "management"
approach in reporting segment information. The management approach designates
the internal organization that is used by management for making operating
decisions and assessing performance as the source of the Company's reportable
segments. It also requires disclosures about products and services, geographic
areas and major customers.
While the Company sells its products to many different markets, its
management has chosen to organize the Company by geographic areas and, as a
result, has determined that it has one reportable segment. All selling and
administrative expenses, interest income, interest expense, depreciation and
amortization are recorded in the United States. In addition, all identifiable
assets are located in the United States except for $175,000 located in Europe at
September 29, 2000.
During the periods ended September 29, 2000 and October 1, 1999, the
Company's international sales were primarily to a few foreign distributors, two
of which have accounted for over 25% of total Company sales during such periods.
Following are the Company's international sales by geographic area (in
thousands) and the percentage of total Company sales generated by two of the
distributors:
Three Months Ended Nine Months Ended
------------------ -----------------
September 29, October 1, September 29, October 1,
2000 1999 2000 1999
---- ----- ------- ----
Net Sales:
United States $4,849 $4,517 $14,626 $14,104
Europe 1,033 1,147 4,080 4,662
Asia 1,111 571 3,983 962
------ ------ ------- -------
$6,993 $6,235 $22,689 $19,728
====== ====== ======= =======
Distributor A 13% 16% 14% 19%
Distributor B 13% Less than 10% 15% Less than 10%
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Net sales of orthopedic products by product category are as follows (in
thousands):
Three Months Ended Nine Months Ended
------------------ -----------------
September 29, 2000 October 1, 1999 September 29, 2000 October 1, 1999
------------------ --------------- ------------------ ---------------
Reconstructive $6,250 $5,375 $20,407 $17,888
Fixation 541 833 1,681 1,728
Other 202 27 601 112
------ ------ ------- -------
$6,993 $6,235 $22,689 $19,728
====== ====== ======= =======
7. RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB No. 101"), which provides guidance on the recognition, presentation and
disclosure of revenue in financial statements. SAB No. 101 will be effective no
later than the fourth fiscal quarter of all fiscal years beginning after
December 15, 1999. The application of SAB No. 101 is not expected to have a
material impact on the financial statements of the Company.
8. LEGAL PROCEEDINGS
Previously the Company has reported that it was engaged in a lawsuit
entitled Wright Medical Technology, Inc. v. Encore Orthopedics, Inc. et al.
Subsequent to the end of the third quarter and prior to the filing of this Form
10-Q, the lawsuit was settled with neither side admitting any wrongdoing or
liability. Concurrently with the settlement of the lawsuit, the Company entered
into an Exclusive Distribution and Supply Agreement with Wright Medical
Technology, Inc. and purchased certain inventory, intellectual property and
other assets.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Results of Operations for the Three Months Ended September 29, 2000 as compared
to the Three Months Ended October 1, 1999.
Sales were $6,993,000 for the quarter ended September 29, 2000, representing an
increase of $758,000 or 12% over the quarter ended October 1, 1999. Sales
outside the U.S. increased $427,000 or 25% compared to the same period in 1999
primarily due to the addition of several new distributors to Encore's
international sales force in the latter half of 1999. The impact of these new
distribution agreements continues to improve sales outside the U.S. U.S. sales
increased to $4,849,000, a 7% gain from the third quarter of 1999. U.S. sales
gains can be attributed to Encore's continued investment in sales force
expansion both in terms of the number of agents and the size of each agency.
Increased sales have resulted in an increase in gross margin which grew 4% or
$182,000 compared to the third quarter of 1999. However, gross margin as a
percent of sales decreased from 68% in 1999 to 64% during the third quarter of
2000 due in large part to production variances and sales mix, both geographical
and product. Sales outside the U.S. carry a lower gross margin than sales to
U.S. customers.
Research and development expenses increased $8,000, a 2% increase over the third
quarter of 1999 reflecting Encore's sustained commitment to new product
development. Current activities include development and testing of a mobile
bearing knee, continued IDE projects and further development of a ceramic femur.
As previously discussed, Encore has continued to expand its worldwide sales
force. This investment resulted in a $267,000 increase in selling, general and
administrative expenses in the third quarter of 2000. However, as a percent of
sales, selling, general and administrative expenses declined from 50.3% in 1999
to 48.6% primarily due to lower commissions associated with sales outside the
U.S.
These factors resulted in a 13% decrease in operating income to $640,000 in
2000, as compared to $733,000 for the quarter ended October 1, 1999.
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Interest expense increased $74,000 for the three months ended September 29,
2000, to $349,000 as compared to the same period in the prior year. This was due
to an increase in the average line of credit balance over this same period last
year and rising interest rates.
Overall, net income for the quarter ended September 29, 2000, decreased $91,000
from 1999 to $288,000. Reduced gross margins and the increased spending
explained above offset the improvement in sales to produce a decline in total
net income. Diluted earnings per share declined from $0.04 in 1999 to $0.03 in
2000.
Results of Operations for the Nine Months Ended September 29, 2000 as compared
to the Nine Months Ended October 1, 1999.
Sales were $22,689,000 for the nine months ended September 29, 2000,
representing an increase of $2,961,000 or 15% over the nine months ended October
1, 1999. Much like the quarter results, sales outside the U.S. increased 43%
over the same period in 1999 and U.S. sales have increased $521,000 or 4%
compared to 1999. These increases are the result of Encore's efforts to enhance
the worldwide sales force.
Gross margin increased $1,296,000 due to the overall increase in sales, however,
gross margin as a percentage of sales was 65% of sales for the nine months ended
September 29, 2000, as compared to 68% of sales in 1999. Again, this was
primarily due to production variances and changes in sales mix, both
geographical and product.
Research and development expenses increased by $150,000 or 13% in 2000 when
compared to the same period in 1999. Activities include development and testing
of a mobile bearing knee, IDE projects, and development of a revision hip system
and a ceramic femur.
Selling, general and administrative expenses increased to $11,295,000, an
increase of 15% as compared to the nine months of the prior year. As in the
quarter results, Encore continued to expend resources to promote its products
and expand its sales force. Also part of this increase was due to higher
royalties associated with the overall increase in sales and agency rights
amortization related to the acquisition of Biodynamic Technologies, Inc.
All of these items have combined to decrease operating income for the nine
months ended September 29, 2000 by 12% to $2,122,000 from $2,408,000 in 1999.
Interest expense increased $273,000 for the nine months ended September 29, 2000
to $962,000 as compared to the prior year. This was due to an increase in the
average line of credit balance over this same period last year, the addition of
notes payable related to the acquisition of Biodynamic Technologies, Inc. on
March 30, 1999 and rising interest rates.
Net income for the nine months ended September 29, 2000 decreased 26% to
$962,000 from $1,298,000 in 1999 as reduced gross margins and increased spending
offset sales increases. Diluted earnings per share declined from $.13 in 1999 to
$.10 in 2000.
Liquidity and Capital Resources
Since inception, the Company has financed its operations through the sale of
equity securities, borrowings and cash flow from operations. The Company has
available to it a $15 million revolving credit facility (the "Credit Facility").
As of September 29, 2000, the Company had drawn approximately $12 million. A
distinguishing feature of the Credit Facility is that Encore's cash management
services are intermingled with it. Encore's bank accounts sweep, on a daily
basis, funds to either reduce or increase the loan balance, as needed, and
invest any excess funds, if the loan balance equals zero, in a money market
account. As such, the outstanding loan balance is adjusted daily based on the
net amount of cash receipts versus cash outlays, while the cash balance at Wells
Fargo remains at zero as long as Encore is a net borrower. This sweep feature
minimizes interest expense and automatically invests any excess funds.
The Company's continued strong growth has resulted in an increase in its capital
requirements. This growth is now primarily funded by the Credit Facility and
cash generated from operations to meet its working capital needs. As of
-8-
September 29, 2000, the Company had net working capital of approximately $26
million as compared to $21 million at December 31, 1999. This increase was
primarily due to increases in inventory.
The Company believes that funds from operations and borrowings under its
existing credit facility will be sufficient to satisfy its anticipated cash
requirements for the next twelve months.
Forward Looking Statements
The foregoing Management's Discussion and Analysis contains various "forward
looking statements" within the meaning of Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934 which represent
Encore's expectations or beliefs concerning future events, including, but not
limited to, statements regarding growth in sales of Encore's products, profit
margins, research and development projects, and the sufficiency of Encore's cash
flow for its future liquidity and capital resource needs. These forward looking
statements are further qualified by important factors that could cause actual
results to differ materially from those in the forward looking statements. These
factors include, without limitation, the effect of competitive pricing, Encore's
dependence on the ability of its third-party manufacturers to produce components
on a basis which is cost-effective to Encore, market acceptance of Encore's
products, the results of FDA regulatory actions, the growth of Encore's sales
force, the exchange rate of the U.S. Dollar compared to other foreign
currencies, and effects of government regulation. Results actually achieved may
differ materially from expected results included in these statements as a result
of these or other factors.
Recent Accounting Pronouncements
In December 1999, the Securities and Exchange Commission staff released Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
No. 101"), which provides guidance on the recognition, presentation and
disclosure of revenue in financial statements. SAB No. 101 will be effective no
later than the fourth fiscal quarter of all fiscal years beginning after
December 15, 1999. The application of SAB No. 101 is not expected to have a
material impact on the financial statements of the Company.
Part II. Other Information
Item 1. Legal Proceedings
Previously the Company has reported that it was engaged in a lawsuit entitled
Wright Medical Technology, Inc. v. Encore Orthopedics, Inc. et al. Subsequent to
the end of the third quarter and prior to the filing of this Form 10-Q, the
lawsuit was settled with neither side admitting any wrongdoing or liability.
Item 2. Changes in Securities
On August 18, 2000, the Company sold 40,000 shares of common stock that were not
registered under the Securities Act of 1933. These shares were sold for a
combination of $400 in cash and services valued at $78,400 to be rendered to the
Company by a consulting surgeon who is an accredited investor. The sales of
these securities are exempt from registration pursuant to Regulation D of the
Securities Act of 1933 and the Rules promulgated thereunder.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 6. Exhibits and Reports on Form 8-K
1. Exhibits. See Index to Exhibits
--------
2. Reports on Form 8-K. The Company filed a Form 8-K on October 4, 2000,
-------------------
relating to the hiring of a new Chief Executive Officer.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
November 10, 2000 By: /s/ Kenneth W. Davidson
- ------------------------- ----------------------------------------
Date Kenneth W. Davidson, Chief Executive Officer
November 10, 2000 By: /s/ August Faske
- ------------------------- ----------------------------------------
Date August Faske, Executive Vice President -
Chief Financial Officer
INDEX TO EXHIBITS
Number Assigned in
Regulation S-K
Item 601 Description of Exhibit
- -------- ----------------------
(2) No exhibit
(4) No exhibit
(10) No exhibit
(11) No exhibit
(15) No exhibit
(18) No exhibit
(19) No exhibit
(22) No exhibit
(23) No exhibit
(24) No exhibit
(27) Financial data schedules
(99) No exhibit
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