1
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 June 30, 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
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ENCORE MEDICAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2000 AND DECEMBER 31, 1999
(in thousands, except share data)
(unaudited)
JUNE 30, DECEMBER 31,
2000 1999
-------- ------------
ASSETS
Cash $ 1 $ 1
Accounts receivable, net 5,015 4,454
Inventories 22,140 19,090
Prepaid expenses and other current assets 965 929
-------- --------
Total current assets 28,121 24,474
Property, plant and equipment, net 5,944 6,218
Goodwill, net 5,063 5,396
Other noncurrent assets 710 827
-------- --------
Total assets $ 39,838 $ 36,915
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current portion - long-term debt $ 674 $ 734
Accounts Payable and accrued expenses 3,260 3,060
-------- --------
Total current liabilities 3,934 3,794
Long-term debt, net of current portion 14,202 12,047
-------- --------
Total liabilities 18,136 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 19,405 19,379
Deferred compensation (240) (288)
Retained earnings 3,949 3,275
Less cost of repurchased stock, warrants, and rights
(322,000 and 278,000 shares, respectively) (1,421) (1,301)
-------- --------
Total stockholders' equity 21,702 21,074
-------- --------
Total liabilities and stockholders' equity $ 39,838 $ 36,915
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
-2-
3
ENCORE MEDICAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2000 AND JULY 2, 1999
(in thousands, except share and per share amounts)
(unaudited)
Three Months Ended Six Months Ended
------------------------------ ------------------------------
June 30, July 2, June 30, July 2,
2000 1999 2000 1999
-------- ------- -------- -------
Sales $ 7,194 $ 6,661 $ 15,695 $ 13,492
Cost of goods sold 2,426 2,116 5,400 4,312
------------ ------------ ------------ ------------
Gross margin 4,768 4,545 10,295 9,180
Operating expenses:
Research and development 460 422 920 778
Selling, general and administrative 3,742 3,331 7,893 6,727
------------ ------------ ------------ ------------
Operating income 566 792 1,482 1,675
Interest expense (325) (272) (613) (414)
Other income 98 82 152 111
------------ ------------ ------------ ------------
Income before income taxes 339 602 1,021 1,372
Current provision for income taxes 122 198 347 452
------------ ------------ ------------ ------------
Net income $ 217 $ 404 $ 674 $ 920
============ ============ ============ ============
Basic earnings per share $ 0.02 $ 0.04 $ 0.07 $ 0.10
Shares used in computing basic earnings
per share 9,022,000 9,094,000 9,023,000 9,095,000
Diluted earnings per share $ 0.02 $ 0.04 $ 0.07 $ 0.09
Shares used in computing diluted earnings
per share 10,006,000 10,304,000 10,091,000 10,369,000
The accompanying notes are an integral part of the consolidated financial
statements.
-3-
4
ENCORE MEDICAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND JULY 2, 1999
(in thousands)
(unaudited)
Six Months Ended
---------------------
June 30, July 2,
2000 1999
-------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 674 $ 920
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization 1,455 1,242
Gain on sale of assets (3) 0
Other 2 0
Changes in operating assets and liabilities:
Increase in accounts receivable (561) (100)
Increase in inventories (3,050) (1,686)
Decrease (increase) in prepaid expenses and other assets 215 (1,191)
Increase (decrease) in accounts payable and accrued expense 200 (896)
------- -------
Net cash used in operating activities (1,068) (1,711)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of Biodynamic Technologies, Inc. 0 (1,114)
Purchases of property and equipment (882) (1,221)
------- -------
Net cash used in investing activities (882) (2,335)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of stock 13 93
Payments to acquire treasury stock (120) (474)
Proceeds from issuance of treasury stock 0 20
Payments on payable to a related party 0 (800)
Payments on long-term debt (409) (281)
Proceeds from long-term debt 2,466 5,488
------- -------
Net cash provided by financing activities 1,950 4,046
------- -------
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.
-4-
5
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 six month periods ended June
30, 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 June 30, 2000 and December 31, 1999 are as follows (in
thousands):
June 30, December 31,
2000 1999
-------- ------------
Components and raw materials $ 4,915 $ 3,953
Work in process 2,444 1,097
Finished goods 15,485 14,811
-------- --------
22,844 19,861
Less-reserve for obsolescence (704) (771)
-------- --------
$ 22,140 $ 19,090
======== ========
5. NET INCOME PER SHARE
Net income per share is computed based on the weighted average number of
outstanding common and common equivalent shares, using methodology required in
Statement of Financial Accounting Standards ("SFAS")
-5-
6
No. 128, "Earnings per Share." Common equivalent shares are not included in the
per share calculation where the effect of their inclusion would be
anti-dilutive.
The reconciliation of the denominators used to calculate the basic and
diluted earnings per share for the periods ended June 30, 2000 and July 2, 1999,
respectively, are as follows (in thousands):
Three Months Ended Six Months Ended
------------------- -------------------
June 30, July 2, June 30, July 2,
2000 1999 2000 1999
-------- ------- -------- -------
Weighted average shares outstanding 9,022 9,094 9,023 9,095
Plus: Common stock equivalents 984 1,210 1,068 1,274
------ ------ ------ ------
Weighted average shares outstanding-diluted 10,006 10,304 10,091 10,369
====== ====== ====== ======
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 6,441,041 and 5,970,350 for the three months ended June 30, 2000 and July
2, 1999, respectively, and 6,501,041 and 5,970,350 for the six months ended June
30, 2000 and July 2, 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. The statement supersedes SFAS No.
14 "Financial Reporting for Segments of a Business Enterprise," replacing the
"industry segment" approach with the "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 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 $213,000 located in Europe at
June 30, 2000.
During the periods ended June 30, 2000 and July 2, 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), the percentage of total Company sales generated by two of the
distributors, and identifiable assets located outside the United States (in
thousands):
Three Months Ended Six Months Ended
------------------ ----------------
June 30, 2000 July 2, 1999 June 30, 2000 July 2, 1999
------------- ------------ ------------- ------------
Net Sales:
United States $ 4,679 $ 4,927 $ 9,777 $ 9,587
Europe 1,306 1,534 3,047 3,510
Asia 1,209 200 2,871 395
------- ------- ------- -------
$ 7,194 $ 6,661 $15,695 $13,492
======= ======= ======= =======
Distributor A 15% 17% 15% 20%
Distributor B 14% Less than 10% 16% Less than 10%
-6-
7
Net sales of orthopedic products by product category are as follows (in
thousands):
Three Months Ended Six Months Ended
------------------ ----------------
June 30, 2000 July 2, 1999 June 30, 2000 July 2, 1999
------------- ------------ ------------- ------------
Reconstructive $ 6,502 $ 6,104 $14,158 $12,513
Fixation 450 481 1,140 895
Other 242 76 397 84
------- ------- ------- -------
$ 7,194 $ 6,661 $15,695 $13,492
======= ======= ======= =======
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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2000 AS COMPARED TO
THE THREE MONTHS ENDED JULY 2, 1999.
Sales were $7,194,000 for the quarter ended June 30, 2000, representing an
increase of $533,000 or 8% over the quarter ended July 2, 1999. Sales outside
the U.S. increased $781,000 or 45% 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 is becoming increasingly visible in the first six months of 2000.
U.S. sales decreased $248,000 or 5% over the quarter ended July 2, 1999.
As a result of the improvements in sales outside the U.S., gross margin has
increased $223,000 or 4.9% compared to the second quarter of 1999. The decline
in gross margin as a percent of sales from 68% in 1999 to 66% during the second
quarter of 2000, was due primarily to the geographic mix of sales since sales
outside the U.S. to distributors carry a lower gross margin than sales to U.S.
customers.
Recognizing the importance of new product development to sustained sales growth,
Encore has continued to invest in research and development activities as
demonstrated by increased expenses of $38,000, a 9% increase over the second
quarter of 1999. Current activities include development and testing of a mobile
bearing knee and development of a revision hip system and ceramic femur.
Even as sales increased in the second quarter of 2000, Encore continued to
expend resources to promote its products and expand its sales force. Evidence of
this can be found in the 12% increase in selling, general and administrative
expenses from the prior year second quarter to a total of $3,742,000.
The net effect of the increase in sales combined with the additional spending
was a 29% decrease in operating income to $566,000 in 2000, as compared to
$792,000 for the quarter ended July 2, 1999.
Interest expense increased $53,000 for the three months ended June 30, 2000, to
$325,000 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 June 30, 2000, decreased $187,000 from
1999 to $217,000. Reduced gross margins and the increased spending explained
above offset the improvement in sales to produce a decline in total net income.
-7-
8
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2000 AS COMPARED TO THE
SIX MONTHS ENDED JULY 2, 1999.
Sales were $15,695,000 for the six months ended June 30, 2000, representing an
increase of $2,203,000 or 16% over the six months ended July 2, 1999. The six
months results mirror the second quarter in that sales outside the U.S.
increased 52% over the same period in 1999. U.S. sales have increased $190,000
or 2% compared to 1999.
Gross margin increased $1,115,000 due to the overall increase in sales, however,
gross margin as a percentage of sales was 66% of sales for the six months ended
June 30, 2000, as compared to 68% of sales in 1999. Like the quarter results,
this was primarily due to a combination of an increase in sales outside the U.S.
and a change in the product mix.
Research and development expenses increased by $142,000 or 18% in 2000 when
compared to the same period in 1999. Activities include development and testing
of a mobile bearing knee and development of a revision hip system and ceramic
femur.
Selling, general and administrative expenses increased to $7,893,000, an
increase of 17% as compared to the six 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, increased clinical
support, and agency rights amortization related to the acquisition of Biodynamic
Technologies, Inc.
Operating income for the six months ended June 30, 2000 decreased 12% to
$1,482,000 from $1,675,000 in 1999.
Interest expense increased $199,000 for the six months ended June 30, 2000 to
$613,000 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 six months ended June 30, 2000 decreased 27% to $674,000 from
$920,000 in 1999 primarily due to reduced gross margins and increased spending.
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 June 30, 2000, the Company had drawn approximately $11 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 June 30,
2000, the Company had net working capital of approximately $24 million as
compared to $21 million at December 31, 1999. This increase was primarily due to
increases in inventory offset by increases in accounts payable and accrued
expenses.
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
-8-
9
manufacturers to produce components on a basis which is cost-effective to
Encore, market acceptance of Encore's products 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
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An annual meeting of stockholders was held on May 25, 2000. All management
nominees for director, as listed in the Proxy Statement for the Annual Meeting,
were elected. The following are the matters voted on at the meeting:
a) Election of directors:
VOTES BROKER NON-VOTES
NAME VOTED FOR VOTED AGAINST WITHHELD AND ABSTENTIONS
---- --------- ------------- -------- ---------------
Nick Cindrich 6,189,971 - 791,056 --
Richard Martin 6,185,857 - 795,170 --
Joel Kanter 6,190,857 - 790,170 --
Craig Smith 6,189,971 - 791,056 --
The following directors terms of office as a director continued after the
meeting: John Abeles, Kenneth Davidson, Dennis Enright, and Jay Haft.
b) Ratification of PricewaterhouseCoopers LLP as independent auditors of the
Company for the fiscal year ending December 31, 2000.
Voted For: 6,273,639
Voted Against: 12,000
Voted Abstained: 695,388
Broker Non-Votes: --
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
1. Exhibits. See Index to Exhibits
2. Reports on Form 8-K. None
-9-
10
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.
August 14, 2000 By: /s/ NICK CINDRICH
- ------------------- --------------------------------------
Date Nick Cindrich,
Chairman of the Board and
Chief Executive Officer
August 14, 2000 By: /s/ AUGUST FASKE
- ------------------- --------------------------------------
Date August Faske,
Vice President - Finance,
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
-10-
11
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
27 Financial Data Schedule