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 March 30, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 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 8,866,300
Part I. Financial Information
Item 1. Financial Statements
Encore Medical Corporation and Subsidiaries
Consolidated Balance Sheets
As of March 30, 2001 and December 31, 2000
(in thousands, except share data)
(unaudited)
March 30, December 31,
2001 2000
---- ----
Assets
Cash and cash equivalents $ 1 $ 1
Accounts receivable, net 6,343 5,417
Inventories 19,771 20,291
Prepaid expenses and other current assets 1,478 1,532
------- -------
Total current assets 26,735 26,383
Property, plant and equipment, net 5,396 5,408
Intangible assets, net 4,542 4,698
Other non current assets 1,155 1,147
------- -------
Total assets $38,686 $38,494
======= =======
Liabilities and Stockholders' Equity
Current portion - long-term debt $ 2,624 $ 3,232
Accounts payable and accrued liabilities 4,212 3,159
------- -------
Total current liabilities 6,836 6,391
Long-term debt, net of current portion 14,144 14,283
------- -------
Total liabilities 20,980 20,674
------- -------
Common stock, $0.001 par value, 35,000,000 shares
authorized, 9,368,000 shares issued 9 9
Additional paid-in capital 19,422 19,405
Deferred compensation (134) (185)
Retained earnings 239 12
Less cost of repurchased stock, warrants and rights
(502,000 and 322,000 shares, respectively) (1,830) (1,421)
------- -------
Total stockholders' equity 17,706 17,820
------- -------
Total liabilities and stockholders' equity $38,686 $38,494
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
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Encore Medical Corporation and Subsidiaries
Consolidated Statements of Operations
For the three months ended March 30, 2001 and March 31, 2000
(in thousands, except per share amounts)
(unaudited)
Three Months Ended
March 30, March 31,
2001 2000
---- ----
Sales $ 8,719 $ 8,501
Cost of goods sold 3,210 2,975
---------- -----------
Gross margin 5,509 5,526
Operating expenses:
Research and development 399 459
Selling, general and administrative 4,466 4,150
---------- -----------
Operating income 644 917
Interest income 4 3
Interest expense (364) (288)
Other income 61 50
---------- -----------
Income before income taxes 345 682
Provision for income taxes 117 225
---------- -----------
Net income $ 228 $ 457
========== ===========
Basic earnings per share $ 0.03 $ 0.05
Shares used in computing basic earnings per share 8,893,000 9,023,000
Diluted earnings per share $ 0.02 $ 0.05
Shares used in computing diluted earnings per share 9,362,000 10,165,000
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 three months ended March 30, 2001 and March 31, 2000
(in thousands,)
(unaudited)
Three Months Ended
March 30, March 31,
2001 2000
---- ----
Cash flows from operating activities:
Net income $ 228 $ 457
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 696 725
Lease income recognized 0 (2)
Loss on disposal of assets 8 7
Changes in operating assets and liabilities:
Increase in accounts receivable (926) (1,676)
Decrease (increase) in inventories 520 (935)
Decrease in prepaid expenses and other assets 46 213
Increase in accounts payable and accrued expenses 1,053 726
------- -------
Net cash provided by (used in) operating activities 1,625 (485)
------- -------
Cash flows from investing activities:
Proceeds on sale of assets 2 0
Purchases of property and equipment (501) (474)
------- -------
Net cash used in investing activities (499) (474)
------- -------
Cash flows from financing activities:
Proceeds from issuance of stock 30 0
Payments to acquire treasury stock - (120)
Payments on long-term obligations (1,163) (196)
Proceeds from long-term obligations 7 1,275
------- -------
Net cash provided by (used in) financing activities (1,126) 959
------- -------
Net increase in cash and cash equivalents 0 0
Cash and cash equivalents at beginning of period 1 1
------- -------
Cash and cash equivalents at end of period $ 1 $ 1
======= =======
Non-cash investing and financing activities:
Repurchase of treasury stock through issuance
of a note $ 409 -
The accompanying notes are an integral part of the consolidated financial
statements.
-4-
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-month period ended March 30,
2001, are not necessarily indicative of the results that may be expected for the
year ending December 31, 2001. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's Form 10-K dated December 31, 2000 (the "Form 10-K"). Certain amounts
in the prior period have been reclassified to conform to current period
presentation.
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. INVENTORIES
Inventories at March 30, 2001 and December 31, 2000 are as follows (in
thousands):
March 30, December 31,
2001 2000
------- -------
Components and raw materials $ 4,332 $ 4,482
Work in process 2,066 2,162
Finished goods 16,574 18,322
------- -------
22,972 24,966
Less-reserve for obsolescence (3,201) (4,675)
------- -------
$19,771 $20,291
======= =======
4. 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.
-5-
The reconciliation of the denominators used to calculate the basic and
diluted earnings per share for the periods ended March 30, 2001 and March 31,
2000, respectively, are as follows (in thousands):
Quarter Ended Quarter Ended
March 30, 2001 March 31, 2000
-------------- --------------
Weighted average shares outstanding-basic 8,893 9,023
Plus: Common stock equivalents 469 1,142
----- ------
Weighted average shares outstanding-diluted 9,362 10,165
===== ======
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 5,715,481 for the first quarter ended March 30, 2001 and
6,262,055 for the quarter ended March 31, 2000.
5. SEGMENT INFORMATION
The Company reports segments utilizing SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," which requires segments to
be identified utilizing a "management" approach. 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 Encore sells its products to many different markets, its management
has chosen to organize Encore 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 is
recorded in the United States. In addition, all identifiable assets are located
in the United States except as noted below.
During the periods ended March 30, 2001 and March 31, 2000, Encore's
international sales were primarily to a few foreign customers, two of which
have accounted for over 25% of total Encore sales during such periods.
Following are Encore's international sales by geographic area (in thousands),
the percentage of total Encore sales generated by two of the customers, and
identifiable assets located outside the United States (in thousands):
For the Quarter Ended
March 30, 2001 March 31, 2000
-------------- --------------
Net Sales:
United States $6,225 $5,099
Europe 1,200 1,741
Asia 1,294 1,661
------ ------
$8,719 $8,501
------ ------
Significant Customers:
Customer A 13% 14%
Customer B 13% 17%
Identifiable Assets:
Europe $ - $ 227
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Net sales of orthopedic products by product category are as follows (in
thousands):
For the Quarter Ended
March 30, 2001 March 31, 2000
-------------- --------------
Reconstructive $7,852 $7,656
Trauma-Fixation 550 691
Spine, Biologics and Other 317 154
------ ------
$8,719 $8,501
------ ------
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations for the Three Months Ended March 30, 2001, as Compared to
the Three Months Ended March 31, 2000.
Sales were $8,719,000 for the quarter ended March 30, 2001, representing an
increase of $218,000 or 3.0% over the quarter ended March 31, 2000. U.S. sales
achieved a record level for any one quarter at $6,225,000, increasing $1,126,000
or 22% compared to the same period in 2000. This was the result of Encore's
efforts over the past six months to strengthen and build the U.S. sales force.
On the other hand, sales outside the U.S. declined $908,000 or 27%, offsetting
much of the increase in U.S. sales. The decline in sales outside the U.S. can
be attributed to Encore's previously announced strategy to focus sales efforts
in the U.S. on more profitable areas.
Even though sales improved over the prior year, gross margin has remained
relatively flat, decreasing $17,000 from the first quarter of 2000. The decline
in gross margin as a percent of sales from 65% in the first quarter of 2000 to
63% during the first quarter of 2001 was due primarily to changes in product mix
and increases in production variances.
Research and development decreased $60,000 or 13% from the first quarter of 2000
due to the approval of products in late 2000 and early 2001, such as the
Keystone(TM) Modular Hip System and the Metal/Metal Acetabular Hip System, that
were in clinical studies in 2000. Current activities include the design of a
new revision shoulder and feasibility studies of a mobile bearing knee product.
In the first quarter of 2001, Encore continued to expend resources to promote
its products and expand its sales force. Evidence of this can be found in the
8% increase in selling, general and administrative expenses from the prior year
first quarter to a total of $4,466,000. In addition to increased commissions
and royalties resulting from higher sales, new expenses were incurred for added
national symposia and sales meetings as compared to the first quarter of 2000.
The net effect of the increase in sales combined with the additional spending
was a decrease in operating income to $644,000 in 2001, as compared to $917,000
for the quarter ended March 31, 2000.
Interest expense increased $76,000 for the three months ended March 30, 2001, to
$364,000 as compared to the same period in the prior year. This was due to the
addition of interest expense on deferred payments related to the Wright Medical
Technology Inc. lawsuit settlement and concurrent Exclusive Supply and
Distribution Agreement reached in the fourth quarter of 2000.
Overall, net income for the quarter ended March 30, 2001, decreased $229,000
from the first quarter in 2000 to $228,000. Reduced gross margins and the
increased spending explained above offset the improvement in sales to result in
a decline in total net income.
-7-
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 $13 million revolving credit facility (the "Credit Facility").
This facility will decrease during the year on a quarterly basis to $10.5
million. In addition, it has a number of financial covenants that must be met
on a quarterly basis. As of March 30, 2001, the Company had drawn approximately
$11 million. As of March 30, 2001, the Company was in compliance with all of
the financial covenants. While the Company's current forecast shows that the
Company will be able to meet the financial covenants during 2001 and will be
able to keep the need for outstanding debt under the maximum ceilings for
amounts outstanding, there is no assurance that the forecasts will prove
accurate or that the bank's requirements will be able to be met. In addition,
there is no assurance that another credit facility will be available as a
replacement to the current facility, which is scheduled to mature in May of
2002. There exists the possibility that the Company will need to obtain
additional equity financing, although there is no assurance as to the amount,
availability or cost of such financing.
During the first quarter ended March 30, 2001, operating activities provided
cash and cash equivalents of $1.6 million primarily due to an increase in
accounts payable and accrued liabilities, a decrease in inventory, and better
collections of accounts receivable. This compares favorably to the first
quarter ended March 31, 2000 where operating activities used cash and cash
equivalents of $0.5 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 growth has resulted in an increase in its capital
requirements. This growth is primarily funded by the Credit Facility and cash
generated from operations to meet its working capital needs. As of March 30,
2001, the Company had net working capital of approximately $21 million similar
to the $21 million net working capital at December 31, 2000.
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 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,
availability of adequate financing alternatives, continual expansion and
productivity of its sales force, 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.
Part II. Other Information
Item 1. Legal Proceedings
None
Item 4. Submission of Matters to a Vote of Security Holders
None.
-8-
Item 6. Exhibits and Reports on Form 8-K
1. Exhibits. See Index to Exhibits
--------
2. Reports on Form 8-K. None
-------------------
-9-
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.
May 14, 2001 By: /s/ Kenneth W. Davidson
- -------------------- -----------------------------------------------
Date Kenneth W. Davidson, Chairman of the Board
and Chief Executive Officer
May 14, 2001 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
(99) No exhibit
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