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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 27, 1997
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 8,847,920
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ENCORE MEDICAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 27, 1997 AND DECEMBER 31, 1996
(in thousands, except share data)
June 27, December 31,
1997 1996
(unaudited) (audited)
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ASSETS
Cash $ 163 $ 472
Accounts receivable, net 6,198 4,467
Inventories 11,122 9,912
Prepaid expenses and other current assets 628 537
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Total current assets 18,111 15,388
Property, plant and equipment, net 5,005 3,931
Other noncurrent assets 1,294 956
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Total assets $ 24,410 $ 20,275
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LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued liabilities $ 2,778 $ 2,612
Current portion - long-term debt 196 164
Current portion - payable to a related party 300 300
Revolving loan -- 2,300
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Total current liabilities 3,274 5,376
Long-term debt, net of current portion 3,282 4,913
Payable to a related party, net of current portion 800 1,100
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Total liabilities 7,356 11,389
Common stock put warrants -- 2,297
Preferred stock, $1.00 par value, 1,000,000 shares authorized, 0 and 587,000
(652,000 equivalent basis) shares issued and outstanding,
respectively (See Note 3) -- 2,935
Common stock, $0.001 par value, 35,000,000 shares
authorized, 8,847,920 shares and 6,334,000 (5,627,000 equivalent basis)
issued and outstanding, respectively (See Note 3) 9 6
Additional paid-in capital and deferred
compensation 17,776 6,315
Accumulated deficit (731) (2,667)
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Total stockholders' equity 17,054 6,589
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Total liabilities and stockholders' equity $ 24,410 $ 20,275
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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 AND SIX MONTHS ENDED JUNE 27, 1997 AND JUNE 28, 1996
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Six Months Ended
June 27, June 28, June 27, June 28,
1997 1996 1997 1996
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Sales $ 6,501 $ 4,106 $ 12,241 $ 7,740
Cost of goods sold 2,020 1,376 3,944 2,581
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Gross margin 4,481 $ 2,730 8,297 5,159
Operating expenses:
Research and development 346 290 751 730
Selling, general and administrative 3,355 1,818 6,084 3,633
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Operating income 780 622 1,462 796
Interest income 58 9 62 24
Interest expense (219) (228) (478) (355)
Other expenses (41) (55) (43) (103)
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Income before extraordinary loss and taxes $ 578 $ 348 $ 1,003 $ 362
Provision for (benefit from) income taxes (349) 52 (229) 57
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Income before extraordinary loss $ 927 $ 296 $ 1,232 $ 305
Extinguishment of debt (net of income taxes) 598 0 598 0
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Net income $ 329 $ 296 $ 634 $ 305
Change in redemption amount of put warrants -- (382) -- (557)
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Net income (loss) applicable to common shares $ 329 $ (86) $ 634 $ (252)
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Net income (loss) applicable to common stock per share
before extraordinary loss $ 0.08 $(0.02) (1) $ 0.13 $(0.05) (1)
Extraordinary loss per share $ (0.03) -- $ (0.04) --
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Net income (loss) applicable to common stock per share $ 0.05 $ (0.02) $ 0.09 $ (0.05)
========== ========== ========== ==========
Weighted average shares outstanding 16,303 5,524 12,949 5,402
(1) Includes the effect of the redemption amount of put warrants.
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 SIX MONTHS ENDED JUNE 27, 1997 AND JUNE 28, 1996
(in thousands) (unaudited)
Six Months Ended
June 27, June 28,
1997 1996
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 634 $ 305
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization 702 427
Amortization of debt discount 65 69
Extinguishment of debt discount 588 --
Net loss on disposal of assets 4 --
Benefit from deferred tax asset (537) --
Other 6 (4)
Changes in operating assets and liabilities:
Increase in accounts receivable (1,731) (1,101)
Increase in inventories (1,210) (3,386)
(Inc.)/dec. in prepaid expenses and other assets 67 (367)
Increase in accounts payable and accrued expenses 166 1,113
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Net cash used in operating activities (1,246) (2,944)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (1,346) (1,190)
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Net cash used in investing activities (1,346) (1,190)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of stock 7,456 465
Payments on payable to a related party (300) (200)
Proceeds from long-term debt 3,220 2,000
Payments on long-term debt (5,793) (60)
Payment on debt issuance costs -- (48)
Net change in cash due to conforming fiscal year-end of
pooled company -- (31)
Payments on revolving loan (2,300) --
Proceeds from revolving loan -- 1,000
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Net cash provided by financing activities 2,283 3,126
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Net decrease in cash equivalents (309) (1,008)
Cash and cash equivalents at beginning of period 472 1,200
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Cash and cash equivalents at end of period $ 163 $ 192
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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 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 period ended June 27, 1997 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1997. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's Joint
Proxy/Prospectus dated February 27, 1997 (the "Joint Proxy/Prospectus").
2. DESCRIPTION OF BUSINESS
The Company 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
they 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.
As explained in Note 3, Encore Orthopedics, Inc. ("Encore") merged
with Healthcare Acquisition, Inc., a wholly-owned subsidiary of Healthcare
Acquisition Corp. ("HCAC").
3. HCAC MERGER
In November 1996, Encore and a wholly owned subsidiary of HCAC, a
publicly traded, specified purpose acquisition company, executed a definitive
agreement and plan of merger. The merger was contingent upon, among other
things, the approval of the shareholders of both Encore and HCAC at meetings
which were held in March 1997. Effective March 25, 1997, the merger was
completed and HCAC's name was changed to Encore Medical Corporation.
The merger was effected by HCAC issuing 0.8884 HCAC common shares and
0.13326 HCAC warrants with an exercise price of $7.00 ("HCAC $7.00 warrants")
for each common share of Encore and 1.11049 HCAC common shares and 0.16657 HCAC
$7.00 warrants for each preferred share of Encore in accordance with the
exchange ratio set forth in the Agreement and Plan of Merger. In addition,
outstanding options and warrants to purchase common stock of Encore were
exchanged for options and warrants to purchase HCAC common stock and HCAC $7.00
warrants based on the exchange ratio discussed above.
For financial reporting and accounting purposes, the merger was
accounted for as a recapitalization of Encore, with the issuance of shares by
Encore for the net assets of HCAC, consisting primarily of cash. As such,
Encore is considered the predecessor company, and the accompanying balance
sheet at December 31, 1996 and statement of income for the three and six months
ended June 27, 1997 are those of Encore and do not include the accounts or
results of operations of HCAC. The capital accounts of Encore at December 31,
1996, however, have been reflected on an equivalent share basis to give effect
to the exchange ratios discussed above. The accompanying statement of income
for the three and six months ended June 27, 1997 includes the results of
operations of HCAC from the effective date of the merger (March 25, 1997)
through the end of the period.
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4. INVENTORIES
Inventories at June 27, 1997 and December 31, 1996 are as follows (in
thousands):
June 27, December 31,
1997 1996
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Components and raw materials $ 2,233 $ 1,563
Work in process 680 985
Finished goods 8,209 7,364
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$ 11,122 $ 9,912
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5. NET INCOME (LOSS) PER SHARE
Net income (loss) per share is computed based on the weighted average
number of outstanding common and common equivalent shares, using the modified
treasury stock method. Common equivalent shares are not included in the per
share calculation where the effect of their inclusion would be anti-dilutive.
For the three and six months ended June 27, 1997, the application of the
modified treasury stock method resulted in an assumed reduction of interest
expense and amortization of debt discount, net of the related tax benefit, and
interest income generated from the assumed investment in U.S. government
securities, net of the related tax expense, of approximately $400,000 and
$500,000, respectively, which has been added to net income available to common
stockholders for purposes of calculating earnings per share.
6. EXTRAORDINARY ITEM
On May 1997, the Company repaid $5 million of long term debt, plus
accrued interest of $39,000. The Company had previously capitalized
approximately $476,000 of financing costs and established a debt discount of
$821,000 associated with detachable, put warrants, issued in accordance with
the debt. The unamortized portions of these two items were expensed in
conjunction with the repayment of the debt, resulting in an extraordinary
charge to earnings of $598,000, net of an income tax benefit of $308,000.
7. DEFERRED TAX VALUATION ALLOWANCE
Prior to fiscal 1997, the Company placed a valuation allowance against
its otherwise recognizable net deferred tax assets due to concerns regarding
the realization of these assets. During the second quarter of fiscal 1997,
management determined that it was probable that the benefits of such deferred
tax assets would be realized and, therefore, eliminated the valuation allowance
of $537,000.
8. RECENT PRONOUNCEMENT
The Financial Accountings Standards Board has issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("FAS 128")
establishing a new methodology for calculating earnings per share. FAS 128 must
be adopted as of December 31, 1997, and earlier adoption is not permitted. Had
net income (loss) applicable to common stock per share been determined under
this new standard, there would have been no change for the three and six months
ended June 28, 1996 from amounts reported, but for the three and six months
ended June 27, 1997, basic earnings per share would have been $0.04 and $0.09,
respectively, and diluted earnings per share would have been $0.03 and $0.07,
respectively.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 27, 1997, AS COMPARED TO
THE THREE MONTHS ENDED JUNE 28, 1996.
Sales increased 58.3% to $6.5 million for the second quarter of 1997, when
compared to $4.1 million for the same period in 1996. U.S. sales increased
82.2% to $3.7 million while sales outside the U.S. increased 35.4% to $2.8
million. The increase was primarily due to the continued expansion of the U.S.
sales force and penetration of the reconstructive device market led by the
Foundation(R) Total Knee System along with increases in the hip and shoulder
systems.
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Gross margin was $4.5 million, or 68.9% of sales, up from $2.7 million or 66.5%
of sales for the same period in 1996. The increase in gross margin was
primarily due to increased sales volume and an increase in U.S. sales, which
generate a greater gross margin than sales outside the U.S.
Selling, marketing, general and administrative expenses increased by $1.5
million, or 84.5% more than for the same period in 1996. The primary
contributors to this increase were commissions and royalties resulting from
increased sales, legal expenses associated with litigation and patent
applications, consulting surgeons' activities such as clinical support,
additional instrumentation depreciation, salaries and benefits due to
additional headcount, and increasing travel expenses. Also, the Company
continued to invest in the development of the U.S. sales infrastructure and
expansion of the business.
Operating income increased by $158,000 or 25.4% when compared to the same
period in 1996. The increase was due to increased gross margins, which was
partially offset by the increased sales, marketing, general and administrative
expenses.
The effective tax rate for the quarter ended June 27, 1997, prior to the impact
of the reversal of the valuation allowance is higher (33%) than the effective
rate for the quarter ended June 28, 1996 (15%). The increase in effective rate
resulted from loss carryforwards and tax credit carryforwards being
substantially utilized in late 1996. A benefit of $537,000 was recognized
during the current quarter resulting from the elimination of the deferred tax
valuation allowance.
Net income for the second quarter of 1997 was $329,000, representing an
increase of 11.1% over the same period in 1996. This increase resulted from
increased operating income and a benefit from the reversal of the deferred tax
asset valuation allowance ($537,000) (see Note 7) which was offset by an
extraordinary charge ($598,000) associated with the extinguishment of debt.
(see Note 6).
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 27, 1997, AS COMPARED TO
THE SIX MONTHS ENDED JUNE 28, 1996.
Sales were $12.2 million for the six months ended June 27, 1997, representing
an increase of $4.5 million or 58.2% over the six months ended June 28, 1996.
U.S. sales and sales outside the U.S. increased 77.7% and 39.8%, respectively,
over the same six month period in 1996. The continued expansion of the U.S.
sales force and penetration of the reconstructive device market led by the
Foundation(R) Total Knee System along with increases in the hip and shoulder
systems were the primary contributors to this increase in sales.
Gross margin increased to $8.3 million, or 67.8% of sales, as compared to 66.7%
of sales for the same six month period in 1996. This gross margin increase
resulted from increased U.S. sales, which generate a greater gross margin than
sales outside the U.S., manufacturing efficiencies and cost controls.
Selling, marketing, general and administrative expenses increased by $2.5
million or 67.5% when compared to the same period in 1996. This increase was
primarily due to commissions and royalties associated with increased sales,
legal expenses associated with litigation and patent applications, consulting
surgeons' activities such as clinical support, additional instrumentation
depreciation, salaries and benefits due to additional headcount, and higher
travel expenses. In addition, the Company continued to invest in the
development of the U.S. sales infrastructure and expansion of the business.
Operating income increased 83.7% to $1.5 million or 11.9% of sales, as compared
to $796,000 for the same period in 1996. This increase was due to increased
gross margins, which was partially offset by increased selling, marketing,
general and administrative expenses.
The effective tax rate for the six months ended June 27, 1997, prior to the
impact of the reversal of the valuation allowance is higher (32%) than the
effective rate for the six months ended June 28, 1996 (16%). The increase in
effective rate resulted from loss carryforwards and tax credit carryforwards
being substantially utilized in late 1996. A benefit of $537,000 was recognized
during the current period resulting from the elimination of the deferred tax
valuation allowance.
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Net income for the six months ended June 27, 1997 increased 107.9% to $634,000
from the same six month period in 1996. The increase in operating income and a
benefit from the reversal of the deferred tax asset valuation allowance
($537,000) (See Note 7) which was offset by and extraordinary charge ($598,000)
associated with the extinguishment of debt (See Note 6).
LIQUIDITY AND CAPITAL RESOURCES
During the second quarter, the Company secured a 2-year, $10 million line of
credit with Wells Fargo Bank. This allowed the Company to retire $5 million of
term debt with Sirrom Capital Corporation and replace a $5 million line of
credit with another bank. As such, the Company now carries any outstanding debt
at a significantly lower interest rate and with lower annual commitment fees.
This new line will allow the Company to fund increased working capital
requirements in accordance with its rapid growth and complements the cash
received from the HCAC merger and from operations. As of June 27, 1997, the
Company had drawn $2.5 million under its line of credit with an eligible
borrowing base of $9.7 million.
Over the past quarter and six month period ended June 27, 1997, the Company
consistently continues to fund primarily the increase in accounts receivable,
inventory, and capital expenditures. These areas will continue to be the
primary uses of funds as the Company grows. The Company believes that through
the combination of cash generated from sales and its credit facilities, the
cash available to meet its needs will be sufficient over at least the next 12
months. It is also anticipated as the Company grows and performs, increased
credit facilities will be available until such time that the outstanding $5
warrants are exercised.
FORWARD LOOKING STATEMENTS
The discussion in this document contains analysis or trends and other forward
looking statements within the meaning of Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. These statements involve management assumptions and are subject to
risks and uncertainties, including the risk factors which are fully described
in the Joint Proxy/Prospectus in "Risk Factors - Risks Relating to Encore" on
pages 21 to 27 thereof, and "Business of Encore" on pages 84 to 94 thereof.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Other than the litigation referred to in Part II, Item 1 of the Form
10-Q for the Quarter ended March 28, 1997, which is hereby incorporated by
reference, there are no pending legal proceedings and there have been no
developments since the filing of the Form 10-K for the quarter ended March 28,
1997 with respect to the litigation referred to in such Form 10-Q.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
1. Exhibits. See Index to Exhibits
2. Reports on Form 8-K. A Form 8-K was filed on April 10, 1997, relating to the
completion of the merger between Healthcare Acquisition Corp. and Encore
Orthopedics, Inc. Included with that Form 8-K was a pro forma balance sheet for
the consolidated companies dated December 31, 1996. Two Form 8-K's were filed
on May 30, 1997, in connection with a change in the principal accounting firm
associated with the Company.
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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.
ENCORE MEDICAL CORPORATION
August 12, 1997 By: /s/ NICK CINDRICH
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Date Nick Cindrich, Chief Executive Officer
August 12, 1997 By: /s/ AUGUST FASKE
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Date August Faske, Chief Financial Officer
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INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
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11 Earnings Per Share Computation
27 Financial Data Schedule