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 July 2, 1999
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 9,142,400
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ENCORE MEDICAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF
JULY 2, 1999 AND DECEMBER 31, 1998
(in thousands, except share data)
(unaudited)
July 2, December 31,
1999 1998
-------- ------------
ASSETS
Cash $ 1 $ 1
Accounts receivable, net 6,538 6,297
Inventories 18,522 16,176
Prepaid expenses and other current assets 561 609
-------- --------
Total current assets 25,622 23,083
Property, plant and equipment, net 6,374 6,147
Goodwill, net 4,084 0
Other noncurrent assets 2,601 1,326
-------- --------
Total assets $ 38,681 $ 30,556
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current portion - long-term debt $ 483 $ 465
Current portion - payable to a related party 0 800
Note Payable 253 0
Accounts Payable and accrued expenses 3,801 3,864
-------- --------
Total current liabilities 4,537 5,129
Long-term debt, net of current portion 13,705 5,603
-------- --------
Total liabilities 18,242 10,732
Common stock, $0.001 par value, 35,000,000 shares
authorized, 9,320,000 and 9,248,000 shares issued,
respectively 9 9
Additional paid-in capital 19,314 19,267
Deferred compensation (361) (310)
Retained earnings 2,576 1,656
Less cost of repurchased stock, warrants and rights (182,000 shares and (1,099) (798)
-------- --------
110,000 shares, respectively)
Total stockholders' equity 20,439 19,824
-------- --------
Total liabilities and stockholders' equity $ 38,681 $ 30,556
======== ========
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 SIX MONTHS ENDED JULY 2, 1999 AND JULY 3, 1998
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Six Months Ended
----------------------------- -----------------------------
July 2, July 3, July 2, July 3,
1999 1998 1999 1998
------------ ------------ ------------ ------------
Sales $ 6,661 $ 6,887 $ 13,492 $ 14,137
Cost of goods sold 2,116 2,295 4,312 4,653
------------ ------------ ------------ ------------
Gross margin 4,545 4,592 9,180 9,484
Operating expenses:
Research and development 422 374 778 852
Selling, general and administrative 3,331 3,669 6,727 7,490
------------ ------------ ------------ ------------
Operating income 792 549 1,675 1,142
Interest expense (272) (107) (411) (189)
Other income 82 4 108 5
------------ ------------ ------------ ------------
Income before income taxes 602 446 1,372 958
Current provision for income taxes 198 122 452 297
------------ ------------ ------------ ------------
Net income $ 404 $ 324 $ 920 $ 661
============ ============ ============ ============
Basic earnings per share $ 0.04 $ 0.04 $ 0.10 $ 0.07
Shares used in computing basic earnings
per share 9,094,000 9,087,000 9,095,000 9,072,000
Diluted earnings per share $ 0.04 $ 0.03 $ 0.09 $ 0.06
Shares used in computing diluted earnings
per share 10,304,000 10,907,000 10,369,000 10,927,000
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 SIX MONTHS ENDED JULY 2, 1999 AND JULY 3, 1998
(in thousands)
(unaudited)
Six Months Ended
July 2, July 3,
1999 1998
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 920 $ 661
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,242 915
Other 0 (9)
Changes in operating assets and liabilities:
Increase in accounts receivable (100) (741)
Increase in inventories (1,686) (1,970)
Decrease in prepaid expenses and other assets (1,191) 149
Decrease in accounts payable and accrued expenses (896) (219)
-------- --------
Net cash used in operating activities (1,711) (1,214)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of Biodynamic Technologies, Inc. (1,114) 0
Purchases of property and equipment (1,221) (1,299)
-------- --------
Net cash used in investing activities (2,335) (1,299)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of stock 93 46
Payments to acquire treasury stock (474) 0
Proceeds from issuance of treasury stock 20 0
Payments on payable to a related party (800) (300)
Payments on long-term debt (281) (174)
Proceeds from long-term debt 5,488 2,933
-------- --------
Net cash provided by financing activities 4,046 2,505
-------- --------
Net (decrease) increase in cash equivalents 0 (8)
Cash and cash equivalents at beginning of period 1 9
-------- --------
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 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 July 2, 1999 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1999. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's Form 10-K
dated December 31, 1998 (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.
3. ACQUISITION OF BIODYNAMIC TECHNOLOGIES, INC.
On March 30, 1999, Encore and Biodynamic Technologies, Inc. ("BTI")
executed a stock purchase agreement whereby Encore 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 $1,098,000 and notes payable 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
$4,157,000 was treated as goodwill which is being amortized over 15 years.
4. INVENTORIES
Inventories at July 2, 1999 and December 31,1998 are as follows (in
thousands):
July 2, December 31,
1999 1998
------- ------------
Components and raw materials $ 4,341 $ 4,159
Work in process 1,260 1,537
Finished goods 12,921 10,480
------- -------
$18,522 $16,176
======= =======
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 July 2, 1999 and July 3, 1998
respectively are as follows (in thousands):
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Three Months Ended Six Months Ended
--------------------------- ---------------------------
July 2,1999 July 3,1998 July 2,1999 July 3,1998
(unaudited) (unaudited) (unaudited) (unaudited)
----------- ----------- ----------- -----------
Weighted average shares outstanding 9,094 9,087 9,095 9,072
Plus: Common stock equivalents 1,210 1,820 1,274 1,855
-------- -------- -------- --------
Weighted average shares outstanding-diluted 10,304 10,907 10,369 10,927
======== ======== ======== ========
Options and warrants to purchase 1,290,885 and 4,679,465 shares of common
stock, respectively, were outstanding at July 2, 1999, 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. SEGMENT INFORMATION
In June 1997, the FASB 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 is recorded in the United States. In addition, all identifiable
assets are located in the United States.
During the periods ended July 2, 1999 and July 3, 1998, the Company's
international sales were primarily to three foreign distributors, one of which
individually accounted for at least 20% of total Company sales during such
periods. Following are the Company's sales by geographic area (in thousands)
and the percentage of total Company sales generated by two of the distributors:
Three Months Ended Six Months Ended
------------------------- --------------------------
July 2,1999 July 3,1998 July 2,1999 July 3,1998
(unaudited) (unaudited) (unaudited) (unaudited)
----------- ----------- ----------- -----------
Net Sales:
United States $ 4,927 $ 4,301 $ 9,587 $ 8,829
Europe 1,534 2,457 5,029 5,029
Asia 200 129 465 279
-------- -------- -------- --------
Total $ 6,661 $ 6,887 $ 15,081 $ 14,137
======== ======== ======== ========
Customer A 17% 23% 20% 22%
Customer B Less than 10% 12% Less than 10% 12%
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JULY 2, 1999 AS COMPARED TO
THE THREE MONTHS ENDED JULY 3, 1998.
Sales were $6,661,000 for the quarter ended July 2, 1999, representing a
decrease of $226,000 or 3.3% less than the quarter ended July 3, 1998. U.S.
sales increased 14.6% over the same period in 1998 primarily due to the
continual growth of the U.S. sales force in the number of sales agents and more
productive sales territories. However, outside
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the U.S. sales have dropped $852,000 or 33% compared to the second quarter of
1998. Encore is actively engaged in pursuing alternative avenues for
international distribution to remedy this situation.
Gross margin decreased $47,000 due to the overall decrease in sales; however,
gross margin as a percentage of sales increased to 68.2% of sales for the three
months ended July 2, 1999, as compared to 66.7% of sales in 1998. This was
primarily due to an increase in U.S. sales, which generate a greater gross
margin than sales outside the U.S.
Research and development expenses increased by $48,000 or 12.8% in 1999 when
compared to the same period in 1998. Research and development activities which
were part of this increase include clinical trials for the ceramic-ceramic hip
system and the metal-metal hip system which were begun in late 1998, and
increased testing on a ceramic knee femur in preparation for beginning
regulatory efforts.
Selling, general and administrative expenses decreased to $3,331,000, a
decrease of 9.2% as compared to the prior year second quarter. While a portion
of this decrease was due to lower commissions and royalties associated with the
overall decrease in sales, the primary reason for the decrease is an ongoing
effort to control expenses, additional leveraging of fixed costs and no charge
for consigned inventory discrepancies.
Because of the efforts in cost control and the improvement in gross margin as a
percentage of sales, operating income increased 44.3% to $792,000, as compared
to $549,000 for the quarter ended July 3, 1998.
Interest expense increased $165,000 for the three months ended July 2, 1999 to
$272,000 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 and the addition
of notes payable related to the acquisition of Biodynamic Technologies, Inc. on
March 30, 1999.
Net income for the quarter ended July 2,1999 increased 24.7% to $404,000 from
$324,000 in 1998 primarily due to the decrease in operating expenses.
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JULY 2, 1999 AS COMPARED TO THE
SIX MONTHS ENDED JULY 3, 1998.
Sales were $13,492,000 for the six months ended July 2, 1999, representing a
decrease of $645,000 or 4.6% over the six months ended July 3, 1998. The six
months results mirror the second quarter results in that U.S. sales increased
8.6% over the same period in 1998 while outside the U.S. sales have dropped
$1,402,000 or 26.4% compared to 1998. To remedy the situation outside the U.S.,
Encore is negotiating with several new distributors to sell Encore products
around the world.
Gross margin decreased $304,000 due to the overall decrease in sales, however,
gross margin as a percentage of sales was 68% of sales for the six months ended
July 2, 1999, as compared to 67.1% of sales in 1998. Like the quarter results,
this was primarily due to a combination of an increase in U.S. sales, which
generate a greater gross margin than sales outside the U.S., continuing
manufacturing efficiencies and cost controls effecting both direct costs and
overhead.
Research and development expenses decreased by $74,000 or 8.7% in 1999 when
compared to the same period in 1998. In the first half of 1998 the design of
two new hip stems and two acetabular systems were completed and released.
Current activities include a joint design effort with Norton Desmarquest Fine
Ceramics to develop a ceramic knee femoral component to address the issue of
polyethylene wear in the knee, and clinical trials for a ceramic-ceramic hip
and a metal-metal hip.
Selling, general and administrative expenses decreased to $6,727,000, a
decrease of 10.2% as compared to the six months of the prior year. Part of this
decrease was due to lower commissions and royalties associated with the overall
decrease in sales. However, unlike 1998, there was no charge in 1999 for
consigned inventory discrepancies. Furthermore, cost controls and additional
leveraging of fixed costs brought this area of expenditures down.
Continuing a trend begun in the later half of 1998, operating income increased
at a much greater rate than sales. In 1999, the increase was 46.7% to
$1,675,000, as compared to $1,142,000 for the six months ended July 3,1998.
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Interest expense increased $225,000 for the six months ended July 2, 1999 to
$414,000 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 and the addition
of notes payable related to the acquisition of Biodynamic Technologies, Inc. on
March 30, 1999.
Net income for the six months ended July 2,1999 increased 39.1% to $920,000
from $661,000 in 1998 primarily due to the decrease in operating expenses.
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. As of July 2, 1999,
the Company had drawn approximately $10 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 July 2, 1999 the Company had net working capital of approximately $21
million as compared to $18 million at December 31, 1998. This increase was
primarily due to increases in inventory and accounts receivable and a decrease
in the current portion of related party debt.
YEAR 2000 COMPLIANCE
The Year 2000 ("Y2K") issue stems from the way dates are recorded and computed
in many computer systems because such programs use only the last two digits to
indicate the year. If uncorrected, these computer programs will be unable to
interpret dates beyond the year 1999, which could cause computer system failure
or other computer errors, thereby disrupting operations. The Company
understands the importance of being prepared for Y2K. The Company's objective
is to ensure an uninterrupted transition into Y2K and is progressing in a
comprehensive plan to assure the achievement of that goal. The scope of the
Year 2000 readiness effort includes (1) evaluating information technology such
as software and hardware; (2) investigating other systems or embedded
technology such as microcontrollers contained in various manufacturing and lab
equipment, environmental and safety systems, and facilities and utilities, and
(3) assessing the readiness of key third parties, including suppliers,
customers, and key financial institutions.
The Company has identified the mission critical systems and has determined the
critical manufacturing and non-manufacturing systems are already Y2K capable,
or replacements, changes, upgrades or workarounds have been identified. These
replacements, changes, upgrades and workarounds are being implemented. The
Company expects to complete compliance testing of all vital systems in the
third quarter of 1999.
The Company's products are not affected by the Year 2000 issue.
The Company is in contact with suppliers, customers and financial institutions
to assure no interruption in the relationship between the Company and these
third parties concerning Y2K compliance issues. Highest priority is being
placed on working with suppliers that are critical to the business. The Company
has made inquiries to all third parties and has received a modest response to
initial inquiries. Follow-up activities will focus on critical suppliers and
the actions being taken to fix Year 2000 problems. Contingency plans are being
developed to address issues related to suppliers that are not considered to be
making sufficient progress in becoming Year 2000 capable in a timely manner.
These plans generally emphasize the identification of alternative suppliers
that are Y2K compliant.
The Company believes that its most likely worst case Year 2000 scenarios would
relate to problems with the systems of third parties rather than with the
Company's internal systems. It is clear that the Company has the least ability
to assess and remediate the Year 2000 problems of third parties and the Company
believes the risks are
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greatest with infrastructure (e.g. electricity supply, water and sewer
service), telecommunications, transportation supply chains and critical
suppliers of materials.
The Company is not in a position to identify or to avoid all possible
scenarios: however, the Company is currently assessing scenarios and taking
steps to mitigate the impacts of various scenarios if they were to occur. This
contingency planning will continue through 1999 as the Company learns more
about the preparations and vulnerabilities of third parties regarding Year 2000
issues. Due to the large number of variables involved, the Company cannot
provide an estimate of the damage it might suffer if any of these scenarios
were to occur.
The Company currently expects that the total cost of Year 2000 programs will
not exceed $400,000. Approximately $270,000 has been spent to date. The
estimated costs do not include any potential costs related to customer or other
claims, or potential amounts related to executing contingency plans, such as
costs incurred on account of an infrastructure or supplier failure. The Company
has adequate general corporate funds with which to pay for the programs'
expected costs. All expected costs are based on the current assessment of the
programs and are subject to change as the programs progress. The Company is
expensing all costs, other than capital equipment purchases, related to the
assessment and remediation of the Y2K issue as incurred. All costs are being
funded through operating cash flows and are not expected to be material to the
Company's consolidated financial condition or results of operations.
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
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An annual meeting of stockholders was held on May 18, 1999. 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
---- --------- ------------- -------- ----------------
Jay M. Haft 6,667,467 -0- 19,256 -0-
Dennis Enright 6,667,467 -0- 19,256 -0-
Kenneth Davidson 6,667,467 -0- 19,256 -0-
The following directors terms of office as a director continued after the
meeting: Nick Cindrich, Craig L. Smith, Richard Martin, Lamar Laster, John
Abeles, and Joel Kanter.
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b) Ratification of PricewaterhouseCoopers L.L.P. as independent auditors of the
Company for the fiscal year ending December 31, 1999.
Voted For: 6,677,082
Voted Against: 1,300
Voted Abstained: 8,341
Broker Non-Votes: -0-
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
1. Exhibits. See Index to Exhibits
2. Reports on Form 8-K. None
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
8-13-99 By: /s/ Nick Cindrich
- ------- ----------------------------------------
Date Nick Cindrich, Chairman of the Board
and Chief Executive Officer
8-13-99 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
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
27 Financial Data Schedule