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 October 1, 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 9,152,400
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ENCORE MEDICAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF OCTOBER 1, 1999 AND DECEMBER 31, 1998
(in thousands, except share data)
(unaudited)
October 1, December 31,
1999 1998
---------- ------------
ASSETS
Cash $ 1 $ 1
Accounts receivable, net 5,933 6,297
Inventories 18,774 16,176
Prepaid expenses and other current assets 401 609
---------- ----------
Total current assets 25,109 23,083
Property, plant and equipment, net 6,189 6,147
Goodwill, net 4,031 0
Other noncurrent assets 2,535 1,326
---------- ----------
Total assets $ 37,864 $ 30,556
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current portion - long-term debt $ 450 $ 465
Current portion - payable to a related party 0 800
Note payable 283 0
Accounts payable and accrued expenses 2,804 3,864
---------- ----------
Total current liabilities 3,537 5,129
Long-term debt, net of current portion 13,466 5,603
---------- ----------
Total liabilities 17,003 10,732
Common stock, $0.001 par value, 35,000,000 shares
authorized, 9,325,000 and 9,248,000 shares issued,
respectively 9 9
Additional paid-in capital 19,306 19,267
Deferred compensation (311) (310)
Retained earnings 2,955 1,656
Less cost of repurchased stock, warrants and rights (182,000 shares and
110,000 shares, respectively) (1,098) (798)
---------- ----------
Total stockholders' equity 20,861 19,824
---------- ----------
Total liabilities and stockholders' equity $ 37,864 $ 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 NINE MONTHS ENDED OCTOBER 1, 1999 AND OCTOBER 2, 1998
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
------------------------- -------------------------
October 1, October 2, October 1, October 2,
1999 1998 1999 1998
---------- ---------- ---------- ----------
Sales $ 6,235 $ 6,363 $ 19,728 $ 20,500
Cost of goods sold 1,955 2,035 6,267 6,688
-------- -------- -------- --------
Gross margin 4,280 4,328 13,461 13,812
Operating expenses:
Research and development 412 421 1,190 1,273
Selling, general and administrative 3,135 3,265 9,863 10,755
-------- -------- -------- --------
Operating income 733 642 2,408 1,784
Interest expense (275) (130) (689) (319)
Other income (expense) 109 (2) 221 3
-------- -------- -------- --------
Income before income taxes 567 510 1,940 1,468
Current provision for income taxes 188 158 642 455
-------- -------- -------- --------
Net income $ 379 $ 352 $ 1,298 $ 1,013
======== ======== ======== ========
Basic earnings per share $ 0.04 $ 0.04 $ 0.14 $ 0.11
Shares used in computing basic earnings
per share 9,139 9,149 9,115 9,104
Diluted earnings per share $ 0.04 $ 0.03 $ 0.13 $ 0.09
Shares used in computing diluted earnings
per share 10,196 10,582 10,313 10,708
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 NINE MONTHS ENDED OCTOBER 1, 1999 AND OCTOBER 2, 1998
(in thousands)
(unaudited)
Nine Months Ended
October 1, October 2,
1999 1998
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,298 $ 1,013
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization 1,954 1,446
Other (1) (8)
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable 494 (181)
Increase in inventories (1,971) (3,142)
Increase in prepaid expenses and other assets (1,076) (156)
Decrease (increase) in accounts payable and accrued expenses (1,873) 227
---------- ----------
Net cash used in operating activities (1,175) (801)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of Biodynamic Technologies, Inc. (1,088) 0
Purchases of property and equipment (1,549) (1,840)
---------- ----------
Net cash used in investing activities (2,637) (1,840)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of stock 101 162
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 (481) (280)
Proceeds from long-term debt 5,446 3,051
---------- ----------
Net cash provided by financing activities 3,812 2,633
---------- ----------
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 nine month periods ended October 1, 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 $1,088,000 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 $4,171,000
was treated as goodwill which is being amortized over 15 years.
4. INVENTORIES
Inventories at October 1, 1999 and December 31, 1998 are as follows (in
thousands):
October 1, December 31,
1999 1998
---------- ------------
Components and raw materials $ 4,064 $ 4,159
Work in process 1,097 1,537
Finished goods 13,613 10,480
---------- ----------
$ 18,774 $ 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 October 1, 1999 and October 2,
1998 respectively are as follows (in thousands):
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Three Months Ended Nine Months Ended
------------------ -----------------
October 1, 1999 October 2, 1998 October 1, 1999 October 2, 1998
--------------- --------------- --------------- ---------------
Weighted average shares outstanding 9,139 9,149 9,115 9,104
Plus: Common stock equivalents 1,057 1,433 1,198 1,604
------ ------ ------ ------
Weighted average shares
outstanding-diluted 10,196 10,582 10,313 10,708
====== ====== ====== ======
Options and warrants to purchase 1,850,646 and 4,678,132 shares of common stock,
respectively, were outstanding at October 1, 1999, but were not included in the
computation of diluted EPS for the three months ended October 1, 1999 because
their exercise price was greater than the average market price of the common
shares. Option and warrants to purchase 1,543,561 and 4,678,132 of common stock
respectively were outstanding at October 1, 1999, but were not included in the
computation of diluted EPS for the nine months ended October 1, 1999 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 October 1, 1999 and October 2, 1998, the
Company's international sales were primarily to four foreign distributors, one
of which individually accounted for at least 19% 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 its
distributors:
Three Months Ended Nine Months Ended
------------------ -----------------
October 1, 1999 October 2, 1998 October 1, 1999 October 2, 1998
--------------- --------------- --------------- ---------------
Net Sales:
United States $ 4,517 $ 4,233 $ 14,104 $ 13,062
Europe 1,147 1,972 4,662 7,002
Asia 571 158 962 436
---------- ---------- ---------- ----------
Total $ 6,235 $ 6,363 $ 19,728 $ 20,500
========== ========== ========== ==========
Distributor A 16% 23% 19% 23%
Distributor B Less than 10% Less than 10% 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 OCTOBER 1, 1999 AS COMPARED TO
THE THREE MONTHS ENDED OCTOBER 2, 1998.
Sales were $6,235,000 for the quarter ended October 1, 1999, representing a
decrease of $128,000 or 2% less than the quarter ended October 2, 1998. U.S.
sales increased 6.7% over the same period in 1998 primarily due to more
productive sales territories. However, outside the U.S. sales have dropped
$412,000 or 19.3% compared to the third
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quarter of 1998. Encore is actively engaged in pursuing alternative avenues for
international distribution to remedy this situation and has recently entered
into distribution agreements for France and the Middle East.
Gross margin decreased $48,000 due to the overall decrease in sales; however,
gross margin as a percentage of sales increased to 68.6% of sales for the three
months ended October 1, 1999, as compared to 68% 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 decreased by $9,000 or 2.1% in 1999 when
compared to the same period in 1998. Research and development activities include
clinical trials for the ceramic-ceramic hip system and the metal-metal hip
system which were begun in late 1998, development of a mobile bearing knee, and
regulatory submissions for spine.
Selling, general and administrative expenses decreased to $3,135,000, a decrease
of 4% as compared to the prior year third quarter. This decrease was primarily
due to lower commissions and royalties associated with the overall decrease in
sales, and due to costs associated with an unsuccessful acquisition attempt in
1998 with no such costs in 1999.
Because of the efforts in cost control and the improvement in gross margin as a
percentage of sales, operating income increased 14.2% to $733,000, as compared
to $642,000 for the quarter ended October 2, 1998. Operating income as a
percentage of sales increased to 11.8% for the third quarter of 1999 as compared
to 10.1% for the third quarter of 1998.
Interest expense increased $145,000 for the three months ended October 1, 1999
to $275,000 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.
Other income increased $111,000 for the three months ended October 1, 1999 to
$109,000 as compared to the prior year primarily due to licensing income.
Net income for the quarter ended October 1, 1999 increased 7.7% to $379,000 from
$352,000 in 1998 primarily due to the decrease in operating expenses.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED OCTOBER 1, 1999 AS COMPARED TO
THE NINE MONTHS ENDED OCTOBER 2, 1998.
Sales were $19,728,000 for the nine months ended October 1, 1999, representing a
decrease of $772,000 or 3.8% over the nine months ended October 2, 1998. The
nine months results mirror the third quarter results in that U.S. sales
increased 8% over the same period in 1998 while outside the U.S. sales have
dropped $1,814,000 or 24.4% compared to 1998.
Gross margin decreased $351,000 due to the overall decrease in sales, however,
gross margin as a percentage of sales was 68.2% of sales for the nine months
ended October 1, 1999, as compared to 67.4% of sales in 1998. Like the quarter
results, 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 decreased by $83,000 or 6.5% 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, clinical trials for a ceramic-ceramic hip and a metal-metal
hip, development of a mobile bearing knee, and regulatory submissions for spine.
Selling, general and administrative expenses decreased to $9,863,000, a decrease
of 8.3% as compared to the nine months of the prior year. This decrease was
primarily due to lower commissions and royalties associated with the overall
decrease in sales, costs associated with unsuccessful acquisition attempts in
1998 with no such costs in 1999, and a charge for consigned inventory
discrepancies in 1998 with no such charge in 1999. In addition, cost controls
and additional leveraging of fixed costs brought this area of expenditures down.
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Continuing a trend begun in the latter half of 1998, operating income increased
at a much greater rate than sales. In 1999, the increase was 35% to $2,408,000,
as compared to $1,784,000 for the nine months ended October 2,1998.
Interest expense increased $370,000 for the nine months ended October 1, 1999 to
$689,000 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.
Other income increased $218,000 for the nine months ended October 1, 1999 to
$221,000 as compared to the prior year. This was due to licensing income and
favorable foreign exchange gains.
Net income for the nine months ended October 1, 1999 increased 28.1% to
$1,298,000 from $1,013,000 in 1998 primarily due to the company wide effort to
control 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 October 1, 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 October
1, 1999 the Company had net working capital of approximately $22 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. As of
October 1999, the Company has completed compliance testing of all vital systems
and has found such systems to be Y2K capable in all significant respects.
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 have focused 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.
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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 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 $325,000 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
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
11-8-99 By: /s/ Nick Cindrich
- -------- ---------------------
Date Nick Cindrich, Chairman of the Board
and Chief Executive Officer
11-8-99 By: /s/ August Faske
- -------- --------------------
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