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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 April 3, 1998
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 9,062,192
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ENCORE MEDICAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF
APRIL 3, 1998 AND DECEMBER 31, 1997 (in thousands, except share data)
(unaudited)
April 3, December 31,
1998 1997
-------- ------------
ASSETS
Cash $ 1 $ 9
Accounts receivable, net 5,220 5,063
Inventories 14,375 13,359
Prepaid expenses and other current assets 571 704
-------- --------
Total current assets 20,167 19,135
Property, plant and equipment, net 5,993 5,099
Other noncurrent assets 1,459 1,487
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Total assets $ 27,619 $ 25,721
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LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued liabilities $ 3,693 $ 3,841
Current portion - long-term debt 400 312
Current portion - payable to a related party 800 300
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Total current liabilities 4,893 4,453
Long-term debt, net of current portion 4,275 2,444
Payable to a related party, net of current portion -- 800
Other long-term liabilities 32 --
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Total liabilities 9,200 7,697
Preferred stock, $1.00 par value, 1,000,000 shares
authorized, 0 and 0 shares issued and
outstanding, respectively -- --
Common stock, $0.001 par value, 35,000,000 shares
authorized, 9,062,192 and 9,047,000 shares issued
and outstanding, respectively 9 9
Additional paid-in capital and deferred compensation 18,195 18,128
Retained earnings (deficit) 215 (113)
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Total stockholders' equity 18,419 18,024
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Total liabilities and stockholders' equity $ 27,619 $ 25,721
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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 MONTHS ENDED APRIL 3, 1998 AND MARCH 28, 1997
(in thousands, except per share amounts)
(unaudited)
Three Months Ended
April 3, March 28,
1998 1997
Sales $ 7,250 $ 5,740
Cost of goods sold 2,358 1,924
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Gross margin 4,892 3,816
Operating expenses:
Research and development 478 405
Selling, general and administrative 3,821 2,729
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Operating income 593 682
Interest income 0 4
Interest income (expense) (82) (259)
Other income (expenses) 1 (3)
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Income before income taxes 512 424
Current provision for income taxes 175 119
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Net income $ 337 $ 305
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Basic earnings per share $ 0.04 $ 0.05
Shares used in computing basic earnings
per share 9,056,000 5,717,000
Diluted earnings per share $ 0.03 $ 0.03
Shares used in computing diluted earnings
per share 10,870,000 8,812,000
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 APRIL 3, 1998 AND MARCH 28, 1997
(in thousands)
(unaudited)
Three Months Ended
April 3, March 28,
1998 1997
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 337 $ 305
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 427 286
Amortization of debt discount 0 39
Other 2 (3)
Changes in operating assets and liabilities:
Increase in accounts receivable (157) (1,105)
Increase in inventories (1,016) (885)
Decrease in prepaid expenses and other assets 153 116
(Dec.) inc. in accounts payable and accrued expenses (116) 1,643
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Net cash (used in) provided by operating activities (370) 396
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (804) (418)
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Net cash used in investing activities (804) (418)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of stock 9 7,446
Payments on payable to a related party (300) (300)
Payments on long-term debt (84) (40)
Net proceeds on line of credit 1,541 900
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Net cash provided by financing activities 1,166 8,006
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Net (decrease) increase in cash equivalents (8) 7,984
Cash and cash equivalents at beginning of period 9 472
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Cash and cash equivalents at end of period $ 1 $ 8,456
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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-month period ended April 3, 1998 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1998. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's Form 10-K dated
December 31, 1997 (the "Form 10-K").
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, during the first quarter of 1997, 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 Healthcare Acquisition, Inc., a
wholly-owned subsidiary of Healthcare Acquisition Corp. ("HCAC"), a publicly
traded, specified purpose acquisition company, executed a definitive agreement
and plan of merger (the "Merger Agreement"). 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 Merger Agreement. 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. The accompanying statement of income for
the three months ended March 28, 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 April 3, 1998 and December 31,1997 are as follows (in
thousands):
April 3, December 31,
1998 1997
---- ----
Components and raw materials $ 2,496 $ 2,711
Work in process 2,563 1,549
Finished goods 9,316 9,099
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$ 14,375 $ 13,359
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 No. 128, "Earnings per Share"
("FAS 128"). 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 April 3, 1998 and March 28,
1997 respectively are as follows (in thousands):
Quarter Ended Quarter Ended
April 3, 1998 March 28, 1997
------------- --------------
(unaudited) (unaudited)
Weighted average shares outstanding-basic 9,056 5,717
Plus: Common stock equivalents 1,814 3,095
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Weighted average shares outstanding-diluted 10,870 8,812
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Options and warrants to purchase 949,167 and 5,842,072 shares of common stock,
respectively, were outstanding at April 3, 1998, but were not included in the
computation of diluted EPS because their exercise price was greater than the
average market price of the common shares.
6. REPORTING COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income." The new standard, which is effective for financial
statements issued for periods ending after December 15, 1997, established
standards for reporting, in addition to net income, comprehensive income and its
components including, as applicable, foreign currency items, minimum pension
liability adjustments and unrealized gains and losses on certain investments in
debt and equity securities. Upon adoption, the Company is also required to
reclassify financial statements for earlier periods provided for comparative
purposes. The Company adopted this standard in the first quarter of 1998. The
impact of this standard on the Company's results is considered immaterial for
disclosure.
7. SEGMENT REPORTING
In June 1997, FASB issued SFAS No. 131, "Disclosure about Segments of
an Enterprise and Related Information," which the Company adopted in the first
quarter of 1998. The standard establishes requirements for reporting information
about operating segments in annual financial statements and requires selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. Under SFAS No. 131,
operating segments are to be determined consistent with the way management
organizes and evaluates financial information internally for making operating
decisions and assessing performance. The disclosure provisions of this standard
are not applicable for interim periods in the year of adoption. The adoption of
this new standard is not expected to have a material impact on the Company's
consolidated balance sheet or statement of income.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS FOR THREE MONTHS ENDED APRIL 3, 1998, AS COMPARED TO THREE
MONTHS ENDED MARCH 28, 1997.
Sales were $7,250,000 for the quarter ended April 3, 1998, representing an
increase of $1,510,000 or 26.3% over the quarter ended March 28, 1997. U.S.
sales increased 50.3% over the same period in 1997. The increase in U.S. sales
was primarily due to the continual growth of the U.S. sales force in the number
of sales agents and more productive sales territories. Outside the U.S.,
existing distributors' growth remains strong while Encore continues to expand
into additional territories. Sales of reconstructive products increased to
$6,819,000 in the first quarter of 1998, led by the Foundation(R) Total Knee,
Hip and Shoulder Systems. Trauma product sales increased 21.1% to $431,000 when
compared to the prior year. The increase in reconstructive products is
attributed primarily to the expansion of the U.S. sales force. The Company
anticipates sales for trauma products to further increase as the transition to
an exclusive sales force is completed in 1998 and the product base is expanded.
Going forward, rapid geographical expansion and introduction of new products
will generate additional increases in sales in both the total joint and trauma
segments of the business.
Gross margin increased to $4,892,000 in 1998, or 67.5% of sales, as compared to
$3,816,000 or 66.5% of sales for 1997. 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.
Research and development expenses increased by $73,000 or 18.0% in 1998 when
compared to the same period in 1997. Research and development activities
increased to complete the design of two new hip stems and two acetabular systems
that were released early this year. A joint design effort with Norton
Desmarquest Fine Ceramics of France was initiated in late 1997, which has
continued into 1998, to develop a ceramic knee femoral component to address the
issue of polyethylene wear in the knee. Initiation of activities that address
polyethylene wear in hip implants included a FDA feasibility study for
metal/metal articulation as well as FDA approval to begin full clinical studies
for metal/metal and ceramic/ceramic hips.
Selling, general and administrative expenses increased by $1,092,000, or 40.0%,
in 1998 when compared to the same period in 1997. This increase was due to
higher commissions associated with the overall increase in sales in conjunction
with a higher percentage growth in U.S. sales (as U.S. sales carry higher
commission rates than sales outside the U.S.). Also, royalties increased in
conjunction with the increase in overall sales. Additionally, there were
increased expenses associated with a greater number of clinical support
activities, expenses associated with being a publicly-traded company, increased
instrumentation depreciation associated with additional instrument sets, and the
continual investment in the expansion of the business and the development of the
U.S. sales infrastructure.
Operating income decreased 13.0% to $593,000, as compared to $682,000 for the
quarter ended March 28, 1997. Increased research and development, selling, and
general and administrative expenses offset the increase in sales and improved
gross margin.
Interest expense decreased to $82,000 for the quarter ended April 3, 1998,
compared to $259,000 for the first quarter of 1997. This decrease was primarily
due to the existence of $5 million of term debt in the first quarter of 1997
that was paid off in the second quarter of 1997.
Net income for the quarter ended April 3, 1998 increased 10.5% to $337,000 from
$305,000 in 1997. This increase was primarily due to the significant decrease in
interest expense offsetting the decrease in operating income.
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 $10 million revolving credit facility (the "Credit
Facility") with an eligible borrowing base as of April 3, 1998 of $9.7 million.
As of April 3, 1998, the Company had drawn $3.3 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,
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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 April 3, 1998, the Company had net working capital of $15.3 million as
compared to $14.7 million at December 31, 1997. This increase was primarily due
to the increases in inventory and accounts receivable offset by the increase in
the current portion of a payment to a related party.
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 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
During 1997, Encore was a party to the lawsuit styled Intermedics Orthopedics,
Inc. vs. Encore Orthopedics, Inc., et al, Cause no. 96-14729, 98th Judicial
District Court of Travis County, Texas. In January 1998, this case reached a
settlement which resulted in a complete dismissal of all the parties with
prejudice. No party admitted any liability as a result of this settlement.
Encore agreed to pay Intermedics Orthopedics, Inc. a nominal amount in
connection with the settlement and to refrain from hiring any of Intermedics'
current sales agents through July 1998. As part of the settlement, all parties
fully released the other parties from all claims they may have had against the
other parties that are related to the subject matter of the lawsuit.
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. None.
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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
May 14, 1998 By: /s/ NICK CINDRICH
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Date Nick Cindrich, Chairman of the Board and
Chief Executive Officer
May 14, 1998 By: /s/ AUGUST FASKE
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Date August Faske, Vice President - Finance,
Chief Financial Officer
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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