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HANGER, INC. - Quarter Report: 2011 March (Form 10-Q)

Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 


 

FORM 10-Q

 

(Mark One)

 

      x

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended March 31, 2011

 

OR

 

 

 

      o

 

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 1-10670

 

HANGER ORTHOPEDIC GROUP, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

84-0904275

(State or other jurisdiction of

 

(IRS Employer Identification No.)

incorporation or organization)

 

 

 

10910 Domain Drive, Suite 300, Austin, TX

 

78758

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (512) 777-3800

 

 

Former name, former address and former fiscal year, if changed since last report.

 

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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T ( 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes o No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one).

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act. Yes o No x

 

As of April 27, 2011 33,497,310 shares of common stock, $.01 par value per share, were outstanding.

 

 

 



Table of Contents

 

HANGER ORTHOPEDIC GROUP, INC.

 

INDEX

 

 

 

Page No.

 

 

 

Part I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Consolidated Financial Statements (unaudited)

 

 

 

 

 

Consolidated Balance Sheets — March 31, 2011 and December 31, 2010

1

 

 

 

 

Consolidated Income Statements for the Three Months ended March 31, 2011 and 2010

3

 

 

 

 

Consolidated Statements of Cash Flows for the Three Months ended March 31, 2011 and 2010

4

 

 

 

 

Notes to Consolidated Financial Statements

5

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

21

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

35

 

 

 

Item 4.

Controls and Procedures

36

 

 

 

Part II.

OTHER INFORMATION

 

 

 

 

Item 1A.

Risk Factors

36

 

 

 

Item 6.

Exhibits

38

 

 

 

SIGNATURES

39

 



Table of Contents

 

HANGER ORTHOPEDIC GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

 

 

 

March 31,

 

December 31,

 

 

 

2011

 

2010

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

CURRENT ASSETS

 

 

 

 

 

Cash and cash equivalents

 

$

19,666

 

$

36,308

 

Accounts receivable, less allowance for doubtful accounts of $16,089 and $16,686 in 2011 and 2010, respectively

 

110,146

 

118,622

 

Inventories

 

99,786

 

98,290

 

Prepaid expenses, other assets, and income taxes receivable

 

21,678

 

17,814

 

Deferred income taxes

 

17,596

 

17,458

 

Total current assets

 

268,872

 

288,492

 

 

 

 

 

 

 

PROPERTY, PLANT AND EQUIPMENT

 

 

 

 

 

Land

 

839

 

839

 

Buildings

 

4,299

 

4,299

 

Furniture and fixtures

 

16,246

 

16,134

 

Machinery and equipment

 

54,477

 

52,905

 

Equipment leased to third parties under operating leases

 

33,010

 

31,294

 

Leasehold improvements

 

60,476

 

59,223

 

Computer and software

 

72,088

 

69,648

 

Total property, plant and equipment, gross

 

241,435

 

234,342

 

Less accumulated depreciation

 

137,000

 

131,038

 

Total property, plant and equipment, net

 

104,435

 

103,304

 

 

 

 

 

 

 

INTANGIBLE ASSETS

 

 

 

 

 

Goodwill

 

595,015

 

590,699

 

Patents and other intangible assets, net

 

56,895

 

56,379

 

Total intangible assets, net

 

651,910

 

647,078

 

 

 

 

 

 

 

OTHER ASSETS

 

 

 

 

 

Debt issuance costs, net

 

20,030

 

16,589

 

Other assets

 

6,347

 

6,016

 

Total other assets

 

26,377

 

22,605

 

 

 

 

 

 

 

TOTAL ASSETS

 

$

1,051,594

 

$

1,061,479

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

1



Table of Contents

 

HANGER ORTHOPEDIC GROUP, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

 

 

 

March 31,

 

December 31,

 

 

 

2011

 

2010

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

CURRENT LIABILITIES

 

 

 

 

 

Current portion of long-term debt

 

$

7,379

 

$

7,006

 

Accounts payable

 

24,540

 

29,243

 

Accrued expenses

 

18,847

 

20,796

 

Accrued interest payable

 

6,350

 

2,522

 

Accrued compensation related costs

 

17,614

 

43,126

 

Total current liabilities

 

74,730

 

102,693

 

 

 

 

 

 

 

LONG-TERM LIABILITIES

 

 

 

 

 

Long-term debt, less current portion

 

510,841

 

501,678

 

Deferred income taxes

 

64,447

 

64,447

 

Other liabilities

 

27,888

 

28,234

 

Total liabilities

 

677,906

 

697,052

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES (Note H)

 

 

 

 

 

 

 

 

 

 

 

SHAREHOLDERS’ EQUITY

 

 

 

 

 

Common stock, $.01 par value; 60,000,000 shares authorized, 34,424,222 shares and 34,352,163 shares issued at 2011 and 2010, respectively

 

349

 

344

 

Additional paid-in capital

 

260,462

 

257,419

 

Accumulated other comprehensive loss

 

(279

)

(279

)

Retained earnings

 

113,812

 

107,599

 

 

 

374,344

 

365,083

 

Treasury stock at cost (141,154 shares)

 

(656

)

(656

)

Total shareholders’ equity

 

373,688

 

364,427

 

 

 

 

 

 

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

 

$

1,051,594

 

$

1,061,479

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

2



Table of Contents

 

HANGER ORTHOPEDIC GROUP, INC.

CONSOLIDATED INCOME STATEMENTS

For the Three Months Ended March 31,

(Dollars in thousands, except share and per share amounts)

(Unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2011

 

2010

 

 

 

 

 

 

 

Net sales

 

$

200,439

 

$

178,316

 

Cost of goods sold - materials

 

58,108

 

53,650

 

Personnel costs

 

78,889

 

68,769

 

Other operating expenses

 

37,390

 

35,315

 

Relocation expenses

 

376

 

2,059

 

Depreciation and amortization

 

7,292

 

4,311

 

Income from operations

 

18,384

 

14,212

 

 

 

 

 

 

 

Interest expense

 

8,379

 

7,542

 

Income before taxes

 

10,005

 

6,670

 

 

 

 

 

 

 

Provision for income taxes

 

3,792

 

2,668

 

Net income

 

$

6,213

 

$

4,002

 

 

 

 

 

 

 

Basic Per Common Share Data

 

 

 

 

 

Net income

 

$

0.19

 

$

0.13

 

Shares used to compute basic per common share amounts

 

33,360,840

 

31,881,750

 

 

 

 

 

 

 

Diluted Per Common Share Data

 

 

 

 

 

Net income

 

$

0.18

 

$

0.12

 

Shares used to compute diluted per common share amounts

 

34,134,067

 

32,926,033

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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Table of Contents

 

HANGER ORTHOPEDIC GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Months Ended March 31,

(Dollars in thousands)

(Unaudited)

 

 

 

2011

 

2010

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

6,213

 

$

4,002

 

Adjustments to reconcile net income to net cash used in operating activities:

 

 

 

 

 

 

 

 

 

 

 

Loss on disposal of assets

 

5

 

27

 

Reduction of earnouts

 

(257

)

 

Provision for bad debts

 

4,078

 

3,599

 

Provision for deferred income taxes

 

(343

)

2,132

 

Depreciation and amortization

 

7,292

 

4,311

 

Amortization of debt issuance costs

 

748

 

455

 

Compensation expense on restricted stock

 

1,658

 

1,916

 

Changes in assets and liabilities, net of effects of acquired companies:

 

 

 

 

 

Accounts receivable

 

5,483

 

2,626

 

Inventories

 

(1,368

)

(1,847

)

Prepaid expenses, other current assets, and income taxes receivable

 

(3,663

)

(8,004

)

Equipment leased to third parties under operating leases

 

(1,722

)

 

Other assets

 

(265

)

(148

)

Accounts payable

 

(6,339

)

(3,942

)

Accrued expenses and accrued interest payable

 

2,323

 

3,252

 

Accrued compensation related costs

 

(25,531

)

(20,684

)

Other liabilities

 

193

 

232

 

Net cash used in operating activities

 

(11,495

)

(12,073

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchase of property, plant and equipment (net of acquisitions)

 

(5,387

)

(7,914

)

Acquisitions and contingent purchase price (net of cash acquired)

 

(4,941

)

(1,185

)

Purchase of technology license/registration of patent

 

(50

)

 

Proceeds from sale of property, plant and equipment

 

3

 

2

 

Net cash used in investing activities

 

(10,375

)

(9,097

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Borrowings under revolving credit agreement

 

10,000

 

 

Repayment of term loan

 

(750

)

(580

)

Repayment of long-term debt

 

(406

)

(688

)

Deferred financing costs

 

(4,189

)

 

Proceeds from issuance of common stock

 

573

 

1,946

 

Net cash provided by financing activities

 

5,228

 

678

 

 

 

 

 

 

 

Decrease in cash and cash equivalents

 

(16,642

)

(20,492

)

Cash and cash equivalents, at beginning of period

 

36,308

 

84,558

 

Cash and cash equivalents, at end of period

 

$

19,666

 

$

64,066

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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Table of Contents

 

HANGER ORTHOPEDIC GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE A — BASIS OF PRESENTATION

 

The unaudited interim consolidated financial statements as of and for the three months ended March 31, 2011 and 2010 have been prepared by Hanger Orthopedic Group, Inc. (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. These consolidated statements are unaudited and, in the opinion of management, include all adjustments (consisting of normal recurring adjustments and accruals) necessary for a fair statement for the periods presented. The year-end consolidated data was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted. The results of operations for the three months ended March 31, 2011 are not necessarily indicative of the results to be expected for the full fiscal year.

 

These consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2010, filed by the Company with the SEC.

 

NOTE B — SIGNIFICANT ACCOUNTING POLICIES

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in the accompanying financial statements.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments with original maturities of three months or less at the date of purchase to be cash equivalents.  At various times throughout the year, the Company maintains cash balances in excess of Federal Deposit Insurance Corporation limits.

 

Inventories

 

Inventories, which consist principally of raw materials, work in process and finished goods, are stated at the lower of cost or market using the first-in, first-out method. For its patient-care centers segment, the Company calculates cost of goods sold—materials in accordance with the gross profit method for all reporting periods. The Company bases the estimates used in applying the gross profit method on the actual results of the most recently completed fiscal year and other factors, such as a change in the sales mix or changes in the trend of purchases. Cost of goods sold—materials during the interim periods are reconciled and adjusted when the annual physical inventory is taken. The Company treats these adjustments as changes in accounting estimates.

 

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Table of Contents

 

NOTE B — SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 

Inventories (continued)

 

For its distribution segment, a perpetual inventory is maintained. Management adjusts the reserve for inventory obsolescence whenever the facts and circumstances indicate that the carrying cost of certain inventory items is in excess of its market price. Shipping and handling activities are reported as part of cost of goods sold—materials.

 

Fair Value

 

Effective January 1, 2008, the Company adopted the authoritative guidance for fair value measurements and disclosures, which establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements.  The authoritative guidance requires disclosure about how fair value is determined for assets and liabilities and establishes a hierarchy by which these assets and liabilities must be grouped, based on significant levels of inputs as follows:

 

Level 1

 

quoted prices in active markets for identical assets or liabilities;

Level 2

 

quoted prices in active markets for similar assets and liabilities and inputs that are observable for the asset or liability;

Level 3

 

unobservable inputs, such as discounted cash flow models and valuations.

 

The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

Effective January 1, 2008, the Company adopted the authoritative guidance that permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings and are immaterial to the Company’s financial statements.

 

Effective January 1, 2009, the Company adopted the authoritative guidance for fair value measurements and disclosures for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. As of December 31, 2010, there has been no impact to the Company’s consolidated financial statements related to the application of fair value measurements and disclosures guidance for non-financial assets and liabilities.

 

The following is a listing of the Company’s assets measured at fair value on a recurring basis and where they are classified within the hierarchy as of March 31, 2011 and December 31, 2010, respectively:

 

 

 

March 31, 2011 (unaudited)

 

December 31, 2010 (unaudited)

 

(in thousands)

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Marketable Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

 

$

 

$

 

$

 

$

17,014

 

$

 

$

 

$

17,014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

$

 

$

 

$

 

$

17,014

 

$

 

$

 

$

17,014

 

 

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Table of Contents

 

NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 

Fair Value (continued)

 

During the three months ended March 31, 2010, assets and liabilities that were measured at fair value using Level 3 inputs had the following activity:

 

 

 

Fair Value Measurements

 

 

 

Using Significant Unobservable Inputs

 

 

 

(Level 3)

 

For the three months ended March 31, 2010

 

Auction
Rate
Securities

 

Rights

 

Total

 

Balance as of December 31, 2009

 

$

6,047

 

$

315

 

$

6,362

 

Total unrealized losses

 

 

 

 

 

 

 

Included in earnings

 

(3

)

4

 

1

 

Balance as of March 31, 2010 (unaudited)

 

$

6,044

 

$

319

 

$

6,363

 

 

For the three months ended March 31, 2011, the Company had no assets or liabilities that were measured at fair value using Level 3 inputs.

 

Investments

 

Trading securities consisted of auction rate securities accounted for in accordance with authoritative guidance for investments in debt and equity securities. Trading securities are reported at fair value with unrealized gains and losses included in earnings. Securities purchased to be held for indeterminate periods of time and not intended at the time of purchase to be held until maturity are classified as available-for-sale securities with any unrealized gains and losses reported as a separate component of accumulated other comprehensive loss on the consolidated balance sheets. The Company’s management continually evaluates whether any marketable investments have been impaired and, if so, whether such impairment is temporary or other than temporary.

 

The Company’s investments consisted of two auction rate securities (“ARS”) totaling $7.5 million of par value, $5.0 million was collateralized by Indiana Secondary Market Municipal Bond—1998 (“Indiana ARS”) and $2.5 million was collateralized by Primus Financial Products Subordinated Deferrable Interest Notes (“Primus ARS”). ARS are securities that are structured with short-term interest rate reset dates which generally occur every 28 days and are linked to LIBOR. At the reset date, investors can attempt to sell via auction or continue to hold the securities at par. The Company’s ARS were reported at fair value at December 31, 2009, and during 2010 both ARS were sold.

 

The fair values of the Company’s ARS were estimated through use of discounted cash flow models. These models consider, among other things, the timing of expected future successful auctions, collateralization of underlying security investments and the credit worthiness of the issuer. Since these inputs are not observable in an active market, they are classified as Level 3 inputs under the fair value accounting rules discussed above under “Fair Value”.

 

The Company recorded no unrealized losses related to the Primus ARS for the three months ended March 31, 2010. The fair value of the Primus ARS as of March 31, 2010 was $1.4 million and was classified as other long term assets. In May 2010, the Company sold its investment in the Primus ARS for $1.5 million.

 

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Table of Contents

 

NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 

Investments (continued)

 

On November 4, 2008, the Company agreed to accept Auction Rate Security Rights (“the Rights”) related to the Indiana ARS from UBS offered through a prospectus filed on October 7, 2008. The Rights permitted the Company to sell, or put, the Indiana ARS back to UBS at par value of $5.0 million, at any time during the period from June 30, 2010 through July 2, 2012 and to obtain a credit line from UBS collateralized by the ARS. The Company elected to classify the Rights and its investments in the Indiana ARS as trading securities in accordance with the authoritative guidance for accounting for investments in debt and equity securities. As of March 31, 2010, the Company determined the fair value of the Indiana ARS was $4.7 million and the fair value of the Rights was $0.3 million. The change in the fair value for December 31, 2009 was $0.1 million and was reflected as a component of earnings.

 

On July 1, 2010, the Company exercised its right to put the ARS back to UBS at par value of $5.0 million. The $5.0 proceeds were received on July 1, 2010. As part of the settlement, the Company closed out a $3.6 million line of credit with UBS that the Company obtained as part of the buyback agreement originally executed in November 2008, with net cash proceeds of approximately $1.4 million.

 

Interest Rate Swaps

 

Prior to December 2010, the Company utilized interest rate swaps to manage its exposure to interest rate risk associated with the Company’s variable rate borrowings. The authoritative guidance for derivatives and hedging requires companies to recognize all derivative instruments as either assets or liabilities at fair value in the consolidated balance sheets. In accordance with the authoritative guidance, the Company designated the interest rate swaps as cash flow hedges of variable-rate borrowings. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive loss and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing hedge ineffectiveness were recognized in earnings.

 

In May 2008, the Company entered into two interest rate swap agreements under which $150.0 million of the Company’s variable rate term loans were converted to a fixed rate of 5.4%. The fair value of each interest rate swap is an estimate of the present value of the expected future cash flows the Company is to receive under the applicable interest rate swap agreement. The valuation models used to determine the fair value of the interest rate swaps are based upon the forward yield curve of one month LIBOR (Level 2 inputs), the hedged interest rate, and other factors including counterparty credit risk. The agreements, which originally expired April 2011, qualified as cash flow hedges in accordance with the authoritative guidance for derivatives and hedging for the three months ended March 31, 2010, and there was no ineffectiveness. The Company’s interest rate swaps qualified for hedge accounting, so any adjustments in fair value related to the effective portion of the interest rate swaps were not required to be recognized through the income statement in that period. Since their inception, the fair value of the interest rate swaps had declined $4.7 million at March 31, 2010. Of the decline, $4.2 million related to the effective portion of the interest rate swaps and was reported as a component of accumulated other comprehensive loss on our consolidated balance sheets. The current portion of the liability, $4.4 million, was reported in accrued expenses, while the remainder was reported in other liabilities on the Company’s consolidated balance sheet as of March 31, 2010.

 

On December 1, 2010, the Company was required to terminate the interest rate swaps due to refinancing of the credit facilities. The Company incurred a loss of $1.6 million, which is recorded in loss/(gain) from interest rate swap on the consolidated income statement.

 

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NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 

Fair Value of Financial Instruments

 

The carrying value of the Company’s short-term financial instruments, such as receivables and payables, approximate their fair values, based on the short-term maturities of these instruments. The carrying value of the Company’s long-term debt, excluding the Senior Notes, approximates fair value based on rates currently available to the Company for debt with similar terms and remaining maturities. The fair value of the Senior Notes, at March 31, 2011, was $204.0 million, as compared to the carrying value of $200.0 million at that date. The fair values of the Senior Notes were based on quoted market prices at March 31, 2011.

 

Revenue Recognition

 

Revenues in the Company’s patient care centers are derived from the sale of O&P devices and the maintenance and repair of existing devices. The sale of O&P devices includes the design, fabrication, assembly, fitting and delivery of a wide range of braces, limbs and other devices. Revenues from the sale of these devices are recorded when (i) acceptance by and delivery to the patient has occurred; (ii) persuasive evidence of an arrangement exists and there are no further obligations to the patient; (iii) the sales price is fixed or determinable; and (iv) collectibility is reasonably assured. Revenues from maintenance and repairs are recognized when the service is provided. Revenues on the sale of O&P devices to customers by the distribution segment are recorded upon the shipment of products, in accordance with the terms of the invoice, net of merchandise returns received and the amount established for anticipated returns. Discounted sales are recorded at net realizable value. Revenues in the therapeutic solutions are primarily derived from leasing rehabilitation technology combined with clinical therapy programs and education and training. The revenue is recorded on a monthly basis according to terms of the contracts with our customers.

 

Revenue at the patient-care centers segment is recorded net of all contractual adjustments and discounts. The Company employs a systematic process to ensure that sales are recorded at net realizable value and that any required adjustments are recorded on a timely basis. The contracting module of the Company’s centralized, computerized billing system is designed to record revenue at net realizable value based on the Company’s contract with the patient’s insurance company. Updated billing information is received periodically from payors and is uploaded into the Company’s centralized contract module and then disseminated, electronically, to all patient-care centers.

 

Disallowed sales generally relate to billings to payors with whom the Company does not have a formal contract. In these situations the Company records the sale at usual and customary rates and simultaneously recognizes a disallowed sale to reduce the sale to net value, based on its historical experience with the payor in question. Disallowed sales may also result if the payor rejects or adjusts certain billing codes. Billing codes are frequently updated. As soon as updates are received, the Company reflects the change in its centralized billing system.

 

As part of the Company’s preauthorization process with payors, it validates its ability to bill the payor, if applicable, for the service provided before the delivery of the device. Subsequent to billing for devices and services, there may be problems with pre-authorization or with other insurance coverage issues with payors. If there has been a lapse in coverage, the patient is financially responsible for the charges related to the devices and services received. If the Company is unable to collect from the patient, a bad debt expense is recognized.

 

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NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

 

Revenue Recognition (continued)

 

Occasionally, a portion of a bill is rejected by a payor due to a coding error on the Company’s part and the Company is prevented from pursuing payment from the patient due to the terms of its contract with the insurance company. The Company appeals these types of decisions and is generally successful. This activity is factored into the Company’s methodology of determining the estimate for the allowance for doubtful accounts. The Company recognizes, as reduction of sales, a disallowed sale for any claims that it believes will not be recovered and adjusts future estimates accordingly.

 

Certain accounts receivable may be uncollectible, even if properly pre-authorized and billed. Regardless of the balance, accounts receivable amounts are periodically evaluated to assess collectibility. In addition to the actual bad debt expense recognized during collection activities, the Company estimates the amount of potential bad debt expense that may occur in the future. This estimate is based upon historical experience as well as a review of the receivable balances.

 

On a quarterly basis, the Company evaluates cash collections, accounts receivable balances and write-off activity to assess the adequacy of the allowance for doubtful accounts. Additionally, a company-wide evaluation of collectibility of receivable balances older than 180 days is performed at least semi-annually, the results of which are used in the next allowance analysis. In these detailed reviews, the account’s net realizable value is estimated after considering the customer’s payment history, past efforts to collect on the balance and the outstanding balance, and a specific reserve is recorded if needed. From time to time, the Company may outsource the collection of such accounts to outsourced agencies after internal collection efforts are exhausted. In the cases when valid accounts receivable cannot be collected, the uncollectible account is written off to bad debt expense.

 

Income Taxes

 

The Company recognizes deferred income tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred income tax liabilities and assets are determined based on the difference between the financial statement and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company recognizes a valuation allowance on the deferred tax assets if it is more likely than not that the assets will not be realized in future years. Significant accounting judgment is required in determining the provision for income taxes and related accruals, deferred tax assets and liabilities. The Company believes that its tax positions are consistent with applicable tax law, but certain positions may be challenged by taxing authorities. In the ordinary course of business, there are transactions and calculations where the ultimate tax outcome is uncertain. In addition, the Company is subject to periodic audits and examinations by the Internal Revenue Service and other state and local taxing authorities. Although the Company believes that its estimates are reasonable, actual results could differ from these estimates.

 

Segment Information

 

The Company applies a “management” approach to disclosure of segment information. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the basis of the Company’s reportable segments. The description of the Company’s reportable segments and the disclosure of segment information are presented in Note L.

 

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NOTE C - SUPPLEMENTAL CASH FLOW FINANCIAL INFORMATION

 

The supplemental disclosure requirements for the statements of cash flows are as follows:

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In thousands)

 

2011

 

2010

 

 

 

(Unaudited)

 

(Unaudited)

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

3,789

 

$

2,534

 

Income taxes

 

1,030

 

3,351

 

 

 

 

 

 

 

Non-cash financing and investing activities:

 

 

 

 

 

Non-cash property, plant and equipment purchases

 

2,628

 

4,413

 

Earnouts payable on acquisitions

 

321

 

 

Unrealized gain on interest rate swaps

 

 

348

 

Issuance of notes in connection with acquistions

 

693

 

 

Issuance of restricted shares of common stock

 

11,566

 

7,837

 

 

NOTE D - GOODWILL

 

The Company determined that it has three reporting units with goodwill to be evaluated, which are the same as its reportable segments: (i) patient-care centers; (ii) distribution; and (iii) therapeutic solutions. The Company completes its annual goodwill impairment analysis in October of each year. The fair value of the Company’s reporting units is primarily determined based on the income approach and considered the market and cost approach. On December 1, 2010, the Company acquired ACP. This transaction resulted in $96.1 million in goodwill, none of which is amortizable for tax purposes.

 

The activity related to goodwill for the three months ended March 31, 2011 and 2010 is as follows:

 

 

 

Patient-Care Centers

 

 

 

Therapeutic

 

 

 

 

 

 

 

Accumulated

 

 

 

Distribution

 

Solutions

 

 

 

(In thousands)

 

Goodwill

 

Impairment Loss

 

Net

 

Goodwill

 

Goodwill

 

Total

 

Balance at December 31, 2010

 

$

502,040

 

$

(45,808

)

$

456,232

 

$

38,388

 

$

96,079

 

$

590,699

 

Additions due to acquisitions

 

3,552

 

 

3,552

 

 

423

 

3,975

 

Additions due to contingent considerations

 

341

 

 

341

 

 

 

341

 

Balance at March 31, 2011 (unaudited)

 

$

505,933

 

$

(45,808

)

$

460,125

 

$

38,388

 

$

96,502

 

$

595,015

 

 

 

 

Patient-Care Centers

 

 

 

Therapeutic

 

 

 

 

 

 

 

Accumulated

 

 

 

Distribution

 

Solutions

 

 

 

(In thousands)

 

Goodwill

 

Impairment Loss

 

Net

 

Goodwill

 

Goodwill

 

Total

 

Balance at December 31, 2009

 

$

491,842

 

$

(45,808

)

$

446,034

 

$

38,388

 

$

 

$

484,422

 

Additions due to acquisitions

 

 

 

 

 

 

 

Additions due to contingent considerations

 

446

 

 

446

 

 

 

446

 

Balance at March 31, 2010 (unaudited)

 

$

492,288

 

$

(45,808

)

$

446,480

 

$

38,388

 

$

 

$

484,868

 

 

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NOTE E INVENTORIES

 

Inventories, which are recorded at the lower of cost or market using the first-in, first-out method, were as follows:

 

 

 

March 31,

 

December 31,

 

(In thousands)

 

2011

 

2010

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

 

 

 

 

Raw materials

 

$

35,653

 

$

36,444

 

Work-in-process

 

41,992

 

38,499

 

Finished goods

 

22,141

 

23,347

 

 

 

$

99,786

 

$

98,290

 

 

NOTE F — ACQUISITIONS

 

On December 1, 2010, the Company completed the acquisition of ACP for approximately $157.8 million in cash and incurred $5.4 million of costs to complete the transaction. These costs, which are reflected as acquisition expenses on the consolidated financial statements, are comprised of $3.3 million in legal and advisor fees and $2.1 million in stock based compensation related to the sale of stock to executives of ACP. The Company recorded: (i) approximately $96.1 million of goodwill, which is not amortizable for tax purposes; (ii) $48.2 million of intangible assets; (iii) $32.5 million of fixed assets at fair value; (iv) $7.2 million of current assets; (v) $6.0 million of current liabilities; and (vi) $20.0 million of deferred tax liabilities related to the ACP transaction. The value of the goodwill from this acquisition can be attributed to a number of business factors including, but not limited to, expected revenue and cash flow growth in future years and the ability to provide patient care services to a previously underserved market. The Company identified intangible assets totaling $48.2 million comprised of; (i) $22.3 million of customer relationships with a useful life of 14 years; (ii) $9.1 million related to the trade name which has an indefinite life; (iii) $8.1 million related to proprietary treatment programs with a useful life of 15 years; (iv) $5.4 million of patented technology with a useful life of eight years; and (v) $3.3 million related to other assets with a three to five year useful life. The results of operations for ACP are included in the Company’s results of operations from the date of acquisition. Pro forma results for the prior period would not be materially different.

 

ACP is the nation’s leading provider of integrated clinical programs for sub-acute and long-term care rehabilitation providers and having contracts to serve more than 4,000 out of a total market of approximately 15,000 skilled nursing facilities (SNF) nationwide, including 22 of the 25 largest national providers. ACP’s unique value proposition is to provide its customers with a full-service “total solutions” approach encompassing proven medical technology, evidence-based clinical programs, and continuous onsite therapist education and training. Their services support increasingly-advanced treatment options for a broader patient population and more medically-complex conditions. The Company financed this transaction through cash on hand and a concurrent refinancing of its senior credit facilities. See Note G for further discussion of refinancing.

 

During the three months ended March 31, 2011, the Company acquired one O&P company, operating a total of one patient care center. The aggregate purchase price for this O&P business was $5.8 million. Of this aggregate purchase price, $0.7 million consisted of promissory notes and $0.6 million is made up of contingent consideration payable within the next two years. Contingent consideration is reported as other liabilities on the Company’s consolidated balance sheet. The Company recorded approximately $3.6 million of goodwill related to this acquisition and the expenses incurred related to this acquisition were insignificant and are included in other operating expenses. The results of operations for this acquisition are included in the Company’s results of operations from the date of acquisition. Pro forma

 

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NOTE F — ACQUISITIONS (CONTINUED)

 

results would not be materially different. The Company made the election to treat the acquisition in the first quarter of 2011 as an asset purchase, and therefore, goodwill is amortizable for tax purposes.

 

In connection with contingent consideration agreements with acquisitions completed prior to adoption of the revised authoritative guidance for business combinations becoming effective, the Company made payments of $0.4 million and $0.8 million during the three months ended March 31, 2011 and 2010, respectively. The Company has accounted for these amounts as additional purchase price, resulting in an increase in goodwill. The Company estimates that it may pay up to a total of $5.8 million related to contingent consideration provisions of acquisitions in future periods. Of the $5.8 million, $4.6 million is related to acquisitions completed after adoption of the revised authoritative guidance.

 

Effective January 1, 2009, the Company adopted the revised authoritative guidance for business combinations, which provides revised guidance to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects.

 

NOTE G — LONG TERM DEBT

 

Long-term debt consists of the following:

 

 

 

March 31,

 

December 31,

 

(In thousands)

 

2011

 

2010

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

 

 

 

 

Revolving Credit Facility

 

$

10,000

 

$

 

Line of Credit

 

 

 

Term Loan

 

299,250

 

300,000

 

7 1/8% Senior Notes due 2018

 

200,000

 

200,000

 

Subordinated seller notes, non-collateralized, net of unamortized discount with principal and interest payable in either monthly, quarterly or annual installments at effective interest rates ranging from 3.00% to 7.00%, maturing through November 2018

 

8,970

 

8,684

 

 

 

518,220

 

508,684

 

Less current portion

 

(7,379

)

(7,006

)

 

 

$

510,841

 

$

501,678

 

 

(1) At March 31, 2010, the Company had $175.0 million outstanding of 101/4% Senior Notes.

(2) At March 31, 2010, the Company had $221.4 million outstanding on the Term Loan at 2.25%.

 

Refinancing and Amendment

 

During the fourth quarter of 2010, the Company refinanced its senior debt through the issuance of $200.0 million of 71/8% Senior Notes due 2018, a new $300.0 million Term Loan Facility which matures in 2016, and the establishment of a $100.0 million Revolving Credit Facility. The Company recorded a $14.0 million charge related to the early extinguishment of the senior debt, comprised primarily of $9.8 million of premiums paid to debt holders and a $4.2 million write-off of debt issuance costs and other fees. The proceeds of the refinancing were used for the following: (i) $184.8 million to retire the outstanding 101/4% Senior notes due 2014 and related premiums and fees; (ii) $220.3 million to retire the outstanding balance under the existing term loan facility; (iii) $16.9 million to pay debt issuance costs; and (iv) $78.2 million for general corporate purposes, including to partially fund the purchase price for the acquisition of ACP.

 

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NOTE G — LONG TERM DEBT (CONTINUED)

 

Refinancing and Amendment (continued)

 

On March 11, 2011, the Company entered into an amendment to its Credit Agreement dated as of December 1, 2010. The amendment (i) reduced the interest rate margin applicable to the term loans under the Credit Agreement by 0.75% to 3.0% and (ii) reduced the LIBOR floor applicable to the term loans under the Credit Agreement from 1.50% to 1.0%. We incurred $4.1 million of fees related to the Amendment which will be amortized into interest expense over the remaining term of the debt.

 

Revolving Credit Facility

 

The $100.0 million Revolving Credit Facility matures on December 1, 2015 and bears interest at LIBOR plus 3.75%, or the applicable rate (as defined in the credit agreement), and includes a 1.50% LIBOR floor. The obligations under the Revolving Credit Facility are guaranteed by the Company’s subsidiaries and are secured by a first priority perfected interest in the Company’s subsidiaries’ shares, all of the Company’s assets, and all the assets of the Company’s subsidiaries. As of March 31, 2011 the stated interest rate is 5.25%.

 

The Revolving Credit Facility requires compliance with various covenants including but not limited to (i) minimum consolidated interest coverage ratio of 3.00:1.00 until September 30, 2011, 3.25:1.00 from October 1, 2011 to September 30, 2012, and 3.50:1.00 thereafter until maturity; (ii) maximum total leverage ratio of 5.00:1.00 until December 31, 2011, 4.50:1.00 from January 1, 2012 to September 30, 2012, and 4.00:1.00 from October 1, 2012 to September 30, 2013, and 3.75:1.00 thereafter until maturity; and (iii) maximum annual capital expenditures of 7.5% of consolidated net revenues of the preceding fiscal year with an additional maximum rollover of $15.0 million from the prior year’s allowance if not expended in the fiscal year for which it is permitted. At March 31, 2011, the Company was in compliance with these covenants. As of March 31, 2011, the Company has $86.6 million available under that facility. Availability under the Company’s Revolving Credit Facility as of March 31, 2011 was net of standby letters of credit of approximately $3.4 million and $10.0 million of outstanding borrowings. The $10.0 million draw was subsequently paid back in April 2011.

 

Line of Credit

 

On April 6, 2009, the Company obtained a collateralized line of credit from UBS in conjunction with the Rights agreement. The credit line was collateralized by the Indiana ARS and allowed the Company to borrow up to the fair market value of the ARS not to exceed its $5.0 million par value. The Company had drawn $3.6 million, which was the maximum currently allowed under the agreement. The credit line had no net cost to the Company as the interest expense was equal to the income on the ARS. On July 1, 2010, the Company settled the $3.6 million line of credit with UBS in conjunction with settling the Rights agreement.

 

Term Loan

 

The $300.0 million Term Loan Facility matures on December 1, 2016 and requires quarterly payments commencing March 31, 2011. From time to time, mandatory payments may be required as a result of capital stock issuances, additional debt incurrences, asset sales, or other events as defined in the credit agreement. The Term Loan Facility bears interest at LIBOR plus 3.0%, or applicable rate (as defined in the credit agreement), and includes a 1.0% LIBOR floor. At March 31, 2011, the interest rate on the Term Loan Facility was 4.00%. The obligations under the Term Loan Facility are guaranteed by the Company’s subsidiaries and are secured by a first priority perfected interest in the Company’s subsidiaries’ shares, all of the Company’s assets, and all the assets of the Company’s subsidiaries. The Term Loan Facility is

 

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NOTE G — LONG TERM DEBT (CONTINUED)

 

Term Loan (continued)

 

subject to covenants that mirror those of the Revolving Credit Facility, and as of March 31, 2011, the Company was in compliance with these covenants.

 

71/8% Senior Notes

 

The 71/8% Senior Notes mature November 15, 2018 and are senior indebtness which is guaranteed on a senior unsecured basis by all of the Company’s current and future domestic subsidiaries. Interest is payable semi-annually on May 15 and November 15 of each year, commencing May 15, 2011.

 

On or prior to November 15, 2013, the Company may redeem up to 35% of the aggregate principal amount of the notes at a redemption price of 107.125% of the principal amount thereof, plus accrued and unpaid interest and additional interest to the redemption date. On or after November 15, 2014, the Company may redeem all or from time to time a part of the notes upon not less than 30 not more than 60 days’ notice, for the twelve month period beginning on November 15, of the indicated years at (i) 103.563% during 2014; (ii) 101.781% during 2015; and (iii) 100.00% during 2016 and thereafter through November 15, 2018.

 

Subsidiary Guarantees

 

The Revolving and Term Loan Facility and the 71/8% Senior Notes are guaranteed by all of the Company’s subsidiaries. Separate condensed consolidating information is not included as the Company does not have independent assets or operations, the Guarantees are full and unconditional and joint and several and any subsidiaries of the Company other than the Guarantor Subsidiaries is minor. There are no restrictions on the ability of our subsidiaries to transfer cash to co-guarantors. All consolidated amounts in the Company’s financial statements are representative of the combined guarantors.

 

Debt Covenants

 

The terms of the Senior Notes, the Revolving Credit Facility, and the Term Loan Facility limit the Company’s ability to, among other things, incur additional indebtedness, create liens, pay dividends on or redeem capital stock, make certain investments, make restricted payments, make certain dispositions of assets, engage in transactions with affiliates, engage in certain business activities and engage in mergers, consolidations and certain sales of assets. At March 31, 2011, the Company was in compliance with all covenants under these debt agreements.

 

NOTE H COMMITMENTS AND CONTINGENT LIABILITIES

 

Commitments

 

The Company’s wholly-owned subsidiary, Innovative Neurotronics, Inc. (“IN, Inc.”), is party to a non-binding purchase agreement under which it agreed to purchase assembled WalkAide System kits. As of March 31, 2011, IN, Inc. had outstanding purchase commitments of approximately $1.1 million that the Company expects to be fulfilled over the next three months.

 

Contingencies

 

The Company is subject to legal proceedings and claims which arise from time to time in the ordinary course of its business, including additional payments under business purchase agreements. In the opinion of management, the amount of ultimate liability, if any, with respect to these actions will not have a materially adverse effect on the financial position, liquidity or results of operations of the Company.

 

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Table of Contents

 

NOTE H COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)

 

Contingencies (continued)

 

The Company is in a highly regulated industry and receives regulatory agency inquiries from time to time in the ordinary course of its business, including inquiries relating to the Company’s billing activities. To date these inquiries have not resulted in material liabilities, but no assurance can be given that future regulatory agencies’  inquiries will be consistent with the results to date or that any discrepancies identified during a regulatory review will not have a material adverse effect on the Company’s consolidated financial statements.

 

Guarantees and Indemnifications

 

In the ordinary course of its business, the Company may enter into service agreements with service providers in which it agrees to indemnify or limit the service provider against certain losses and liabilities arising from the service provider’s performance of the agreement. The Company has reviewed its existing contracts containing indemnification or clauses of guarantees and does not believe that its liability under such agreements is material to the Company’s operations.

 

NOTE I — NET INCOME PER COMMON SHARE

 

Basic per common share amounts are computed using the weighted average number of common shares outstanding during the year. Diluted per common share amounts are computed using the weighted average number of common shares outstanding during the year and dilutive potential common shares. Dilutive potential common shares consist of stock options and restricted shares and are calculated using the treasury stock method.

 

Net income per share is computed as follows:

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In thousands, except share and per share data)

 

2011

 

2010

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

 

 

 

 

Net income

 

$

6,213

 

$

4,002

 

 

 

 

 

 

 

Shares of common stock outstanding used to compute basic per common share amounts

 

33,360,840

 

31,881,750

 

Effect of dilutive restricted stock and options (1)

 

773,227

 

1,044,283

 

Shares used to compute dilutive per common share amounts

 

34,134,067

 

32,926,033

 

 

 

 

 

 

 

Basic income per share

 

$

0.19

 

$

0.13

 

Diluted income per share

 

0.18

 

0.12

 

 


(1) There were no anti-dilutive options for the three months ended March 31, 2011 and 2010.

 

NOTE J — SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN

 

The Company’s unfunded noncontributory defined benefit plan (the “Plan”) covers certain senior executives, is administered by the Company, and calls for annual payments upon retirement based on years of service and final average salary. Benefit costs and liabilities balances are calculated based on certain assumptions including benefits earned, discount rates, interest costs, mortality rates and other factors. Actual results that differ from the assumptions are accumulated and amortized over future periods, affecting the recorded obligation and expense in future periods.

 

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Table of Contents

 

NOTE J — SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN (CONTINUED)

 

The following assumptions were used in the calculation of the net benefit cost and obligation at March 31, 2011:

 

Discount rate

 

4.75

%

Average rate of increase in compensation

 

3.00

%

 

The Company believes the assumptions used are appropriate; however, changes in assumptions or differences in actual experience may affect our benefit obligation and future expenses. The change in the Plan’s net benefit obligation is as follows:

 

 

 

(In thousands)

 

 

 

 

 

Net benefit cost accrued at December 31, 2010

 

$

17,059

 

Service cost

 

247

 

Interest cost

 

202

 

Net benefit cost accrued at March 31, 2011 (unaudited)

 

$

17,508

 

 

NOTE K - STOCK-BASED COMPENSATION

 

The Company utilizes the authoritative guidance using the modified prospective method. Under the modified prospective method, compensation expense related to awards granted prior to and unvested as of the adoption of the authoritative guidance is calculated in accordance with the authoritative guidance and recognized in the consolidated statements of operations over the requisite remaining service period; compensation expense for all awards granted after the adoption of the authoritative guidance is calculated according to the provisions of such guidance.

 

On May 13, 2010, the stockholders of the Company approved the 2010 Omnibus Incentive Plan (the “2010 Plan”) and terminated the Amended and Restated 2002 Stock Incentive and Bonus Plan (the “2002 Plan”) and the 2003 Non-Employee Directors’ Stock Incentive Plan (the “2003 Plan”). No new awards will be granted under the 2002 Plan or the 2003 Plan; however, awards granted under either the 2002 Plan or the 2003 Plan that were outstanding on May 13, 2010 remain outstanding and continue to be subject to all of the terms and conditions of the 2002 Plan or the 2003 Plan.

 

The 2010 Plan provides that 2.5 million shares of Common Stock are reserved for issuance, subject to adjustment as set forth in the 2010 Plan; provided, however, that only 1.5 million shares may be issued pursuant to the exercise of incentive stock options. Of these 2.5 million shares, 2.0 million are shares that are newly authorized for issuance under the 2010 Plan and 0.5 million are unissued shares not subject to awards that have been carried over from the shares previously authorized for issuance under the terms of the 2002 Plan and the 2003 Plan. Unless earlier terminated by the Board of Directors, the 2010 Plan will remain in effect until the earlier of (i) the date that is ten years from the date the plan is approved by the Company’s stockholders, which is the effective date for the plan, namely May 13, 2020, or (ii) the date all shares reserved for issuance have been issued.

 

At March 31, 2011, of the 2.5 million shares of common stock authorized for issuance under the Company’s 2010 Plan, approximately 0.5 million shares have been issued. During the first quarter of 2011, the Company issued approximately 0.4 million shares of restricted stock under the 2010 plan. The fair value on the date of grant was $11.4 million.

 

Total unrecognized share-based compensation cost related to unvested restricted stock awards was approximately $18.8 million at March 31, 2011, and is expected to be expensed as compensation expense over approximately four years. The Company had no unrecognized expense related to its stock option grants for the periods ended March 31, 2011 and 2010.

 

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Table of Contents

 

NOTE K - STOCK-BASED COMPENSATION (CONTINUED)

 

During the three months ended March 31, 2011 and 2010, no options were cancelled under the 2002 Stock Incentive and Bonus Plan. There were no 2003 Directors’ Plan option cancellations during the three months ended March 31, 2011 and 2010.

 

For the three months ended March 31, 2011 and 2010, the Company has included approximately $1.7 million and $1.9 million, respectively, for share-based compensation cost in the accompanying condensed consolidated statements of income for the 2002, 2003, and 2010 Plans. Compensation expense relates to restricted share grants. The Company calculates the fair value of stock options using the Black-Scholes model. The total value of the stock option awards is expensed ratably over the requisite service period of the employees receiving the awards.

 

NOTE L — SEGMENT AND RELATED INFORMATION

 

The Company has identified three reportable segments in which it operates based on the products and services it provides. The Company evaluates segment performance and allocates resources based on the segments’ income from operations. In December 2010, as a result of the acquisition of ACP, the Company realigned its reportable segments and identified the third operating segment. Therapeutic solutions include ACP and IN, Inc., which previously was included in Other. The results of IN, Inc. have been reclassified to Therapeutic Solutions in all years presented.

 

The reportable segments are: (i) patient-care services (ii) distribution, and (iii) therapeutic solutions. The reportable segments are described further below:

 

Patient-Care Services—This segment consists of the Company’s owned and operated patient-care centers and fabrication centers of O&P components. The patient-care centers provide services to design and fit O&P devices to patients. These centers also instruct patients in the use, care and maintenance of the devices. Fabrication centers are involved in the fabrication of O&P components for both the O&P industry and the Company’s own patient-care centers.

 

Distribution—This segment distributes O&P products and components to both the O&P industry and the Company’s own patient-care practices.

 

Therapeutic Solutions—This segment consists of the leasing of rehabilitation equipment from ACP as well the operations of IN, Inc. ACP is a developer of specialized rehabilitation technologies and provides evidence-based clinical programs for post-acute rehabilitation. IN, Inc. specializes in bringing emerging MyoOrthotics Technologies® to the O&P market. MyoOrthotics Technologies represents the merging of orthotic technologies with electrical stimulation.

 

Other—This consists of Hanger corporate and Linkia. Linkia is a national managed-care agent for O&P services and a patient referral clearing house.

 

The accounting policies of the segments are the same as those described in the summary of “Significant Accounting Policies” in Note B to the consolidated financial statements.

 

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NOTE L — SEGMENT AND RELATED INFORMATION (CONTINUED)

 

Summarized financial information concerning the Company’s reportable segments is shown in the following table. Intersegment sales mainly include sales of O&P components from the distribution segment to the patient-care services segment and were made at prices which approximate market values.

 

(In thousands)

 

Patient-Care
Services

 

Distribution

 

Therapeutic
Solutions

 

Other

 

Consolidating
Adjustments

 

Total

 

 

 

(Unaudited)

 

(Unaudited)

 

(Unaudited)

 

(Unaudited)

 

(Unaudited)

 

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 

 

 

 

 

 

 

 

 

 

 

 

Customers

 

$

160,551

 

$

23,461

 

$

16,257

 

$

170

 

$

 

$

200,439

 

Intersegments

 

 

41,627

 

745

 

 

(42,372

)

 

Depreciation and amortization

 

2,961

 

284

 

2,474

 

1,573

 

 

7,292

 

Income (loss) from operations

 

22,373

 

6,887

 

751

 

(11,728

)

101

 

18,384

 

Interest (income) expense

 

7,116

 

849

 

1,440

 

(1,026

)

 

8,379

 

Income (loss) before taxes

 

15,257

 

6,038

 

(689

)

(10,702

)

101

 

10,005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital Expenditures

 

3,082

 

168

 

90

 

2,047

 

 

5,387

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 

 

 

 

 

 

 

 

 

 

 

 

Customers

 

$

156,046

 

$

21,817

 

$

351

 

$

102

 

$

 

$

178,316

 

Intersegments

 

 

38,154

 

982

 

 

(39,136

)

 

Depreciation and amortization

 

2,774

 

240

 

78

 

1,219

 

 

4,311

 

Income (loss) from operations

 

24,434

 

6,134

 

(1,484

)

(14,815

)

(57

)

14,212

 

Interest (income) expense

 

7,089

 

851

 

 

(398

)

 

7,542

 

Income (loss) before taxes

 

17,345

 

5,283

 

(1,484

)

(14,417

)

(57

)

6,670

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital Expenditures

 

6,782

 

453

 

587

 

92

 

 

7,914

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2011

 

1,137,977

 

149,344

 

140,001

 

(375,728

)

 

1,051,594

 

December 31, 2010

 

1,054,270

 

146,166

 

142,970

 

(281,927

)

 

1,061,479

 

 

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NOTE M — CORPORATE OFFICE RELOCATION

 

The Company moved its corporate headquarters from Bethesda, Maryland to Austin, Texas during the year ended December 31, 2010. In conjunction with the move, the Company incurred employee separation costs, other relocation costs, and lease termination costs. Employee separation costs are expensed pro-ratably over the requisite service period. The Company incurred employee separation and relocation costs of $0.4 million during the three months ended March 31, 2011. The Company anticipates incurring $1.0 to $2.0 million of additional costs in 2011 as the final employee moves are completed.  As of August 31, 2010 the Company abandoned its lease premises in Bethesda, Maryland and recorded a lease termination liability of $4.6 million, net of anticipated sub-lease recoveries. The lease termination liability will be paid out over the remaining term of the lease which expires on September 30, 2014.

 

The following is a summary of the relocation incurred and to be paid in future periods:

 

(in thousands)

 

Employee
Separation

 

Other
Relocation

 

Lease
Termination

 

Total

 

Balance as of December 31, 2010

 

$

1,895

 

$

 

$

5,206

 

$

7,101

 

Expenses incurred

 

36

 

340

 

 

376

 

Amounts paid

 

(926

)

 

(641

)

(1,567

)

Balance as of March 31, 2011

 

$

1,005

 

$

340

 

$

4,565

 

$

5,910

 

 

 

 

Employee
Separation

 

Other
Relocation

 

Lease
Termination

 

Total

 

Balance as of December 31, 2009

 

$

 

$

 

$

 

$

 

Expenses incurred

 

1,527

 

532

 

 

2,059

 

Amounts paid

 

 

 

 

 

Balance as of March 31, 2010

 

$

1,527

 

$

532

 

$

 

$

2,059

 

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

The following is a discussion of our results of operations and financial condition for the periods described below. This discussion should be read in conjunction with the Consolidated Financial Statements included in this report. Our discussion of our results of operations and financial condition includes various forward-looking statements about our markets, the demand for our products and services and our future results. These statements are based on our current expectations, which are inherently subject to risks and uncertainties. Refer to risk factors disclosed in Part II, Item 1A of this filing as well as the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 for further discussion of risks and uncertainties. Our actual results and the timing of certain events may differ materially from those indicated in the forward looking statements.

 

Business Overview

 

General

 

The goal of Hanger Orthopedic Group, Inc. (the “Company”) is to be the world’s premier provider of services and products that enhance human physical capabilities. We provide orthotic and prosthetic patient care services, distribute O&P devices and components, manage O&P networks, and provide therapeutic solutions to the broader post acute market. We are the largest owner and operator of orthotic and prosthetic patient care centers in the United States and the largest dedicated distributor of O&P products in the United States. We operate in excess of 675 O&P patient care centers located in 45 states and the District of Columbia and five strategically located distribution facilities. In addition to providing O&P services and products we, through our subsidiary, Linkia LLC (“Linkia”), manage an O&P network and develop programs to manage all aspects of O&P patient care for insurance companies. We provide therapeutic solutions through our subsidiaries Innovative Neurotronics and Accelerated Care Plus. Innovative Neurotronics (“IN, Inc.”) introduces emerging neuromuscular technologies developed through independent research in a collaborative effort with industry suppliers worldwide. Accelerated Care Plus (“ACP”) is a developer of specialized rehabilitation technologies and a leading provider of evidence-based clinical programs for post-acute rehabilitation serving more than 4,000 long-term care facilities and other sub-acute rehabilitation providers throughout the U.S.

 

For the three months ended March 31, 2011, our net sales were $200.4 million and we recorded net income of $6.2 million. For the three months ended March 31, 2010, our net sales were $178.3 million, and we recorded net income of $4.0 million.

 

We have three segments—patient care services, distribution, and therapeutic solutions. For the three months ended March 31, 2011, net sales attributable to our patient-care services, distribution, and therapeutic solutions segments were $160.6 million, $23.5 million, and $16.3 million, respectively. See Note L to our consolidated financial statements contained herein for further information related to our segments.

 

Industry Overview

 

We provide goods and services to the O&P, post-acute, and other rehabilitation markets. We estimate that the O&P patient care market in the United States is approximately $2.6 billion, of which we account for approximately 27%, and the post-acute rehabilitation and other rehabilitation market is approximately $1.3 billion, of which we account for 5%. We commissioned a study which identified additional opportunities to leverage our expertise beyond the traditional O&P market, and we believe these additional opportunities could potentially expand our available O&P market by an additional $1.4 billion to $4.0 billion.

 

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The O&P patient care services market is highly fragmented and is characterized by local, independent O&P businesses, with the majority of these businesses generally having a single facility with annual revenues of less than $1.0 million. We do not believe that any single competitor accounts for more than 2% of the country’s total estimated O&P patient care services revenue.

 

The O&P services industry is characterized by stable, recurring revenues, primarily resulting from new patients as well as the need for periodic replacement and modification of O&P devices. Based on our experience, the average replacement time for orthotic devices is one to three years, while the average replacement time for prosthetic devices is three to five years. There is also an attendant need for continuing O&P patient care services. In addition to the inherent need for periodic replacement and modification of O&P devices and continuing care, we expect the demand for O&P services will continue to grow as a result of several key trends, including the aging of the U.S. population, resulting in an increase in incidence of disease, and the demands for new and advanced devices.

 

We estimate the post-acute rehabilitation market to include approximately 15,000 skilled nursing facilities and to have a market potential of approximately $0.2 billion. We provide technologically advanced rehabilitation equipment and clinical programs to approximately 30% of the post-acute market. We estimate the broader rehabilitation markets, which include independent rehabilitation providers and providers in other post-acute settings, to be approximately $1.1 billion. We currently provide goods and services to very few customers in this portion of the market, however, we believe this market would benefit from our products and services.

 

Business Strategy

 

Our goal is to be the provider of choice for products and services that enhance human physical capabilities. We focus on disciplined diversification of our revenue streams both within our traditional orthotic and prosthetics market and in complimentary and adjacent markets that expand our continuum of care. In addition, we continue to focus on gaining operational efficiencies and expanding the market share of our core businesses. We have implemented a strategy of disciplined diversification through internal efforts by developing business such as IN, Inc., Linkia, Dosteon, CARES, and in adjacent markets through the acquisition of SureFit and ACP.

 

Our internal efforts focus on leveraging the resources and expertise of our core O&P patient care services business in order to provide additional products and services to our patients. IN, Inc. was created to bring innovative applications and product technology to market. IN, Inc.’s first two products are the WalkAide and V-Hold and both are good examples of bringing new products to the O&P market place. Our knowledge of the O&P market place enabled us to create Linkia, which is the only O&P provider network management service company that functions as a liaison between provider networks and third party health insurance companies. Linkia provides insurance payors with data and administrative services that allow these payors to provide higher quality more efficient care to their insureds; in return this solidifies our relationship with payors and allows us to negotiate favorable national or regional contracts. We continually assess market opportunities to identify additional opportunities to leverage our footprint and expertise beyond the traditional O&P market. We have identified and are piloting two new channels of revenue; CARES and Dosteon. CARES is a pilot program that works with hospital emergency rooms to provide a wide variety of orthotic and durable medical equipment (“DME”) products, while Dosteon partners with physicians offices, such as orthopedic and vascular surgeons to provide for the postoperative needs of their patients. These pilot businesses, along with dedicated sales personnel, help us sell into markets not previously served by our traditional brick and mortar facilities. We are encouraged with the progress of these businesses and their ability to contribute to the growth of our patient care business.

 

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We continually look to diversify our revenue streams outside of our core O&P business. We have executed this through the acquisition of SureFit and ACP. SureFit, which is a part of our distribution business, expanded our continuum of care into the podiatry market by providing custom shoe inserts and shoes. ACP, which combined with IN, Inc., comprises our Therapeutic Solutions segment. Therapeutic Solutions provides the platform to expand into the post-acute and other rehabilitation markets by providing technologically advanced therapeutic equipment and related clinical protocols which enhance the productivity and outcomes of rehabilitative care. We also look to leverage the relationships we have with the rehabilitation providers in order to provide our traditional O&P offerings to their patients.

 

It is also our goal to continue to provide superior patient care and be the most cost-efficient, full service, national O&P operator distributor. The key elements of our strategy to achieve this goal are to:

 

·                  Improve our performance by:

 

·                  investing in and developing new processes to improve the productivity of our practitioners and our distribution centers, including the use of scanning technology as well as development of a comprehensive electronic practice management system;

 

·                  continuing periodic patient evaluations to gauge patient satisfaction as well as the functionality of their device;

 

·                  improving the utilization and efficiency of administrative and corporate support services;

 

·                  enhancing margins through continued consolidation of vendors and product offering; and

 

·                  leveraging our market share to increase sales and improve pricing;

 

·                  Increase our market share and net sales by:

 

·                  continued marketing of Linkia to regional and national providers and contracting with national and regional managed care providers who we believe select us as a preferred O&P provider because of our reputation, national reach, density of the network and our ability to monitor quality and outcomes while reducing administrative expenses;

 

·                  increasing the volume of our patient care business through enhanced comprehensive marketing programs aimed at referring physicians and patients. Our patient Evaluation Clinics program, allows patients to have their devices inspected and serviced if necessary. The program also informs them of technological improvements which may benefit them by further improving their mobility. Our “People in Motion” program also introduces potential patients to the latest O&P technology;

 

·                  expanding the breadth of products being offered through our distribution segment and our patient care centers;

 

·                  increasing the number of practitioners through our residency program; and

 

·                  Selectively acquiring small and medium-sized O&P patient care service businesses and opening satellite patient-care centers primarily to expand our presence within an existing market and secondarily to enter into new markets.

 

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Business Description

 

Patient Care Services

 

As of March 31, 2011, we provided O&P patient care services through over 675 patient-care centers and over 1,100 practitioners in 45 states and the District of Columbia. Substantially all of our practitioners are certified, or are candidates for formal certification, by the O&P industry certifying boards. A practitioner manages each of our patient-care centers. Our patient-care centers also employ highly trained technical personnel who assist in the provision of services to patients and who fabricate various O&P devices, as well as office administrators who schedule patient visits, obtain approvals from payors and bill and collect for services rendered.

 

In our orthotics business, we design, fabricate, fit and maintain a wide range of custom-made braces and other devices (such as spinal, knee and sports-medicine braces) that provide external support to patients suffering from musculoskeletal disorders, such as ailments of the back, extremities or joints and injuries from sports or other activities. In our prosthetics business, we design, fabricate, fit and maintain custom-made artificial limbs for patients who are without limbs as a result of traumatic injuries, vascular diseases, diabetes, cancer or congenital disorders. O&P devices are increasingly technologically advanced and are custom-designed to add functionality and comfort to patients’ lives, shorten the rehabilitation process and lower the cost of rehabilitation. Patients are referred to Hanger by an attending physician who determines a patient’s treatment and writes a prescription. Our practitioners then consult with both the referring physician and the patient with a view toward assisting in the design of an orthotic or prosthetic device to meet the patient’s needs.

 

The fitting process often involves several stages in order to successfully achieve desired functional and cosmetic results. The practitioner creates a cast and takes detailed measurements, frequently using our digital imaging system (Insignia), of the patient’s residual limb to ensure an anatomically correct fit. Prosthetic devices are custom fabricated and fit by skilled practitioners. The majority of the orthotic devices provided by us are custom designed, fabricated and fit; the remainder are prefabricated but custom fit.

 

Custom devices are fabricated by our skilled technicians using plaster castings, measurements and designs made by our practitioners and by utilization of our proprietary Insignia system. The Insignia system replaces plaster casting of a patient’s residual limb with a computer generated image. Insignia provides a very accurate image, faster turnaround for the patient, and a more professional overall experience. Technicians use advanced materials and technologies to fabricate a custom device under quality assurance guidelines. Custom designed devices that cannot be fabricated at the patient-care centers are fabricated at one of several central fabrication facilities.

 

To provide timely service to our patients, we employ technical personnel and maintain laboratories at many of our patient-care centers. We have earned a strong reputation within the O&P industry for the development and use of innovative technology in our products, which has increased patient comfort and capability, and can significantly enhance the rehabilitation process. The quality of our services and the success of our technological advances have generated broad media coverage, building our brand equity among payors, patients and referring physicians.

 

Provider Network Management

 

Linkia is the first provider network management company dedicated solely to serving the O&P market. Linkia is dedicated to managing the O&P services of national and regional insurance companies. Linkia partners with healthcare insurance companies by securing a national or regional contract either as a

 

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preferred provider or to manage their O&P network of providers. Linkia’s network now includes approximately 1,000 O&P provider locations, including approximately 350 independent providers. As of March 31, 2011, Linkia had 43 contracts with national and regional providers.

 

Distribution Services

 

We distribute O&P components to independent customers and to our own patient-care centers through our wholly-owned subsidiary, SPS, which is the nation’s largest dedicated O&P distributor. We are also a leading manufacturer and distributor of therapeutic footwear for diabetic patients in the podiatric market. SPS maintains in inventory approximately 26,000 individual SKUs manufactured by more than 50 different companies. SPS maintains distribution facilities in California, Florida, Georgia, Pennsylvania, and Texas, which allows us to deliver products via ground shipment anywhere in the contiguous United States typically within two business days.

 

Our distribution business enables us to:

 

·                  centralize our purchasing and thus lower our material costs by negotiating purchasing discounts from manufacturers;

 

·                  reduce our patient-care center inventory levels and improve inventory turns;

 

·                  perform inventory quality control;

 

·                  encourage our patient-care centers to use clinically appropriate products that enhance our profit margins; and

 

·                  coordinate new product development efforts with key vendor “partners”.

 

Marketing of our distribution services is conducted on a national basis through a dedicated sales force, print and e-commerce catalogues, and exhibits at industry and medical meetings and conventions. We direct specialized catalogues to segments of the healthcare industry, such as orthopedic surgeons, physical and occupational therapists, and podiatrists.

 

Therapeutic Solutions

 

We provide therapeutic solutions to the O&P market and post-acute rehabilitation market through its subsidiaries IN, Inc. and ACP. IN, Inc. specializes in product development, principally in the field of functional electrical stimulation. Working with the inventors under licensing and consulting agreements, IN, Inc. commercializes the design, obtains regulatory approvals, develops clinical protocols for the technology, and then introduces the devices to the marketplace through a variety of distribution channels. IN, Inc.’s first product, the WalkAide System (“WalkAide”), has received FDA approval, achieved ISO 13485:2004 and ISO 9001:2000 certification, as well as the European CE Mark, which are widely accepted quality management standards for medical devices and related services. IN, Inc. is conducting trials in its effort to gain additional coverage for stroke rehabilitation which represents the largest potential patient population. IN, Inc. anticipates that these trials will be completed by the end of 2011 with submission of data to CMS during 2012. In addition to reimbursement from Medicare and Medicaid, IN, Inc. has been working with commercial insurance companies and has had limited success in obtaining payment for the WalkAide device. The WalkAide is sold in the United States through our patient care centers and SPS. IN, Inc. is also marketing the WalkAide internationally through licensed distributors.

 

On December 1, 2010 we acquired ACP, which is the nation’s leading provider of rehabilitation technologies and integrated clinical programs to rehabilitation providers. We have contracts to serve more than 4,000 skilled nursing facilities nationwide, including 22 of the 25 largest national providers. Our

 

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unique value proposition is to provide our customers with a full-service “total solutions” approach encompassing proven medical technology, evidence based clinical programs, and continuous onsite therapist education and training. Our services support increasingly advanced treatment options for a broader patient population and more medically complex conditions.

 

Competitive Strengths

 

We believe the combination of the following competitive strengths will help us in growing our businesses through an increase in our net sales, net income and market share:

 

·                  Leading market position both in the O&P market place and in the post acute rehabilitation markets;

 

·      National scale of operations, which better enables us to:

 

·      establish our brand name and generate economies of scale;

 

·      implement best practices throughout the Company;

 

·      utilize shared fabrication facilities;

 

·      contract with national and regional managed care entities;

 

·      identify, test and deploy emerging technology; and

 

·      increase our influence on, and input into, regulatory trends;

 

·                  Distribution of, and purchasing power for, O&P components and finished O&P products, which enables us to:

 

·                  negotiate greater purchasing discounts from manufacturers and freight providers;

 

·                  reduce patient-care center inventory levels and improve inventory turns through centralized purchasing control;

 

·                  quickly access prefabricated and finished O&P products;

 

·                  promote the usage by our patient-care centers of clinically appropriate products that also enhance our profit margins;

 

·                  engage in co-marketing and O&P product development programs with suppliers; and

 

·                  expand the non-Hanger client base of our distribution segment;

 

·                  Development of leading-edge technology to be brought to market through our patient practices and licensed distributors worldwide;

 

·                  Practitioner compensation plans that financially reward practitioners for their efficient management of accounts receivable collections, labor, materials, and other costs, and encourage cooperation among our practitioners within the same local market area;

 

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·                  Proven ability to rapidly incorporate technological advances in the fitting and fabrication of O&P devices;

 

·                  History of successful integration of small and medium-sized O&P business acquisitions, including 90 O&P businesses since 1997, representing over 200 patient-care centers;

 

·                  Highly trained practitioners, whom we provide with the highest level of continuing education and training through programs designed to inform them of the latest technological developments in the O&P industry, and our certification program in conjunction with the University of Hartford;

 

·                  Experienced and committed management team; and

 

·                  Successful government relations efforts which enables us to:

 

·                  Support our patients’ efforts to pass “The Prosthetic Parity Act” in 19 states;

 

·                  Increase Medicaid reimbursement levels in several states; and

 

·                  Create the Hanger Orthopedic Political Action Committee (The Hanger PAC).

 

Critical Accounting Policies and Estimates

 

Our analysis and discussion of our financial condition and results of operations is based upon our Consolidated Financial Statements that have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  GAAP provides the framework from which to make these estimates, assumptions and disclosures. We have chosen accounting policies within GAAP that management believes are appropriate to accurately and fairly report our operating results and financial position in a consistent manner. Management regularly assesses these policies in light of current and forecasted economic conditions. Our accounting policies are stated in Note B to the Consolidated Financial Statements included elsewhere in this report.  We believe the following accounting policies are critical to understanding our results of operations and the more significant judgments and estimates used in the preparation of our Consolidated Financial Statements.

 

·                  Revenue Recognition:  Revenues in our patient care centers are derived from the sale of O&P devices and the maintenance and repair of existing devices. The sale of O&P devices includes the design, fabrication, assembly, fitting and delivery of a wide range of braces, limbs and other devices. Revenues from the sale of these devices are recorded when (i) acceptance by and delivery to the patient has occurred; (ii) persuasive evidence of an arrangement exists and there are no further obligations to the patient; (iii) the sales price is fixed or determinable; and (iv) collectibility is reasonably assured. Revenues from maintenance and repairs are recognized when the service is provided. Revenues on the sale of O&P devices to customers by the distribution segment are recorded upon the shipment of products, in accordance with the terms of the invoice, net of merchandise returns received and the amount established for anticipated returns. Discounted sales are recorded at net realizable value. Revenues in our therapeutic solutions are primarily derived from leasing rehabilitation technology combined with clinical therapy programs and education and training. The revenue is recorded on a monthly basis according to terms of the contracts with our customers.

 

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Revenue at our patient-care centers segment is recorded net of all contractual adjustments and discounts. We employ a systematic process to ensure that our sales are recorded at net realizable value and that any required adjustments are recorded on a timely basis. The contracting module of our centralized, computerized billing system is designed to record revenue at net realizable value based on our contract with the patient’s insurance company. Updated billing information is received periodically from payors and is uploaded into our centralized contract module and then disseminated to all patient-care centers electronically.

 

The following represents the composition of our accounts receivable balance by type of payor:

 

March 31, 2011 (unaudited)

 

 

 

 

 

 

 

 

 

(In thousands)

 

0-60 days

 

61-120 days

 

Over 120 days

 

Total

 

Commercial and other

 

$

50,211

 

$

10,421

 

$

10,140

 

$

70,772

 

Private pay

 

4,573

 

3,912

 

2,512

 

10,997

 

Medicaid

 

10,970

 

1,969

 

2,260

 

15,199

 

Medicare

 

22,858

 

2,211

 

2,107

 

27,176

 

VA

 

1,529

 

316

 

246

 

2,091

 

 

 

$

90,141

 

$

18,829

 

$

17,265

 

$

126,235

 

 

December 31, 2010 (unaudited)

 

 

 

 

 

 

 

 

 

(In thousands)

 

0-60 days

 

61-120 days

 

Over 120 days

 

Total

 

Commercial and other

 

$

59,827

 

$

9,000

 

$

8,439

 

$

77,266

 

Private pay

 

7,088

 

2,304

 

1,324

 

10,716

 

Medicaid

 

11,331

 

2,019

 

2,276

 

15,626

 

Medicare

 

25,522

 

2,330

 

1,777

 

29,629

 

VA

 

1,491

 

432

 

148

 

2,071

 

 

 

$

105,259

 

$

16,085

 

$

13,964

 

$

135,308

 

 

Disallowed sales generally relate to billings to payors with whom we do not have a formal contract. In these situations, we record the sale at usual and customary rates and simultaneously record an estimate to reduce the sale to net realizable value, based on our historical experience with the payor in question. Disallowed sales may also result if the payor rejects or adjusts certain billing codes. Billing codes are frequently updated within our industry. As soon as updates are received, we reflect the change in our centralized billing system.

 

As part of our preauthorization process with payors, we validate our ability to bill the payor for the service we are providing before we deliver the device. Subsequent to billing for our devices and services, there may be problems with pre-authorization or other insurance coverage issues with payors. If there has been a lapse in coverage, the patient is financially responsible for the charges related to the devices and services received. If we do not collect from the patient, a bad debt expense is recognized.

 

Occasionally, a portion of a bill is rejected by a payor due to a coding error on our part and we are prevented from pursuing payment from the patient due to the terms of our contract with the insurance company. We appeal these types of decisions and are generally successful. This activity is factored into our methodology to determine the estimate for the allowance for doubtful accounts. We immediately record, as a reduction of sales, a disallowed sale for any claims that we know we will not recover and adjust our future estimates accordingly.

 

Certain accounts receivable may be uncollectible, even if properly pre-authorized and billed. Regardless of the balance, accounts receivable amounts are periodically evaluated to assess collectibility. In addition to the actual bad debt expense recognized during collection activities,

 

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we estimate the amount of potential bad debt expense that may occur in the future. This estimate is based upon our historical experience as well as a review of our receivable balances.

 

·                  Inventories:  Inventories, which consist principally of raw materials, work in process and finished goods, are stated at the lower of cost or market using the first-in, first-out method. At our patient-care centers segment, we calculate cost of goods sold—materials in accordance with the gross profit method for all reporting periods. We base the estimates used in applying the gross profit method on the actual results of the most recently completed physical inventory and other factors, such as sales mix and purchasing trends among other factors. Cost of goods sold—materials is adjusted once the annual physical inventory is taken and the valuation is completed in the fourth quarter. We treat these inventory adjustments as changes in accounting estimates.

 

At our distribution segment, a perpetual inventory is maintained. We adjust our reserve for inventory obsolescence whenever the facts and circumstances indicate that the carrying cost of certain inventory items is in excess of its market price. Shipping and handling costs are included in cost of goods sold—materials.

 

·                  Goodwill and Other Intangible Assets:  Goodwill represents the excess of purchase price over the value assigned to net identifiable assets of purchased businesses. We assess goodwill for impairment annually on October 1, or when events or circumstances indicate that the carrying value of the reporting units may not be recoverable. Any impairment would be recognized by a charge to operating results and a reduction in the carrying value of the intangible asset. Our annual impairment test for goodwill primarily utilizes the income approach and considers the market approach and the cost approach in determining the value of our reporting units. Non-compete agreements are recorded based on agreements entered into by us and are amortized, using the straight-line method, over their terms ranging from five to seven years. Other definite-lived intangible assets are recorded at cost and are amortized, using the straight-line method, over their estimated useful lives of up to 17 years. Whenever the facts and circumstances indicate that the carrying amounts of these intangibles may not be recoverable, we review and assess the future cash flows expected to be generated from the related intangible for possible impairment. Any impairment would be recognized as a charge to operating results and a reduction in the carrying value of the intangible asset. As of October 1, 2010, there were no indicators of impairment as the fair value of the reporting units was substantially in excess of their carrying value. As of March 31, 2011, there were no indicators of impairment.

 

·                  Income taxes:  We are required to estimate income taxes in each of the jurisdictions in which the Company operates. This process involves estimating the actual current tax liability together with assessing temporary differences in recognition of income (loss) for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Consolidated Balance Sheet. We then assess the likelihood that the deferred tax assets will be recovered from future taxable income and, to the extent that we believe that recovery is not likely, we establish a valuation allowance against the deferred tax asset.

 

We recognize liabilities for uncertain tax positions based on a two-step process. The first step requires us to determine if the weight of available evidence indicates that the tax position has met the threshold for recognition; therefore, we must evaluate whether it is more likely than not that the position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step requires us to measure the tax benefit of the tax position taken, or expected to be taken, in an income tax return as the largest amount that is more than 50% likely of being realized upon ultimate settlement. This measurement step is inherently complex and requires subjective estimations of such amounts to determine the probability of various possible outcomes. We re-evaluate the uncertain tax positions each quarter based on factors including, but

 

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not limited to, changes in facts or circumstances, changes in tax law, expirations of statutes of limitation, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision in the period.

 

Although we believe the measurement of our liabilities for uncertain tax positions is reasonable, no assurance can be given that the final outcome of these matters will not be different than what is reflected in the historical income tax provisions and accruals. If additional taxes are assessed as a result of an audit or litigation, it could have a material effect on the income tax provision and net income in the period or periods for which that determination is made. We operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions. These audits can involve complex issues which may require an extended period of time to resolve and could result in additional assessments of income tax. We believe adequate provisions for income taxes have been made for all periods.

 

Results of Operations

 

The following table sets forth for the periods indicated certain items from our Consolidated Statements of Operations as a percentage of our net sales:

 

 

 

Three Months Ended
March 31,

 

 

 

2011

 

2010

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

 

 

 

 

Net sales

 

100.0

%

100.0

%

Cost of goods sold - materials

 

29.0

 

30.1

 

Personnel costs

 

39.4

 

38.6

 

Other operating expenses

 

18.7

 

19.9

 

Relocation expenses

 

0.2

 

1.2

 

Depreciation and amortization

 

3.6

 

2.4

 

Income from operations

 

9.1

 

7.8

 

Interest expense

 

4.2

 

4.2

 

Income before taxes

 

4.9

 

3.6

 

Provision for income taxes

 

1.9

 

1.5

 

Net income

 

3.0

%

2.1

%

 

Three Months Ended March 31, 2011 Compared to the Three Months Ended March 31, 2010

 

Net Sales.  Net sales for the three months ended March 31, 2011 increased by $22.1 million, or 12.4%, to $200.4 million from $178.3 million for the three months ended March 31, 2010. The sales increase was principally the result of a $15.9 million increase in therapeutic solutions segment, a $1.6 million or 7.5% increase in external sales of our distribution segment, a $0.3 million or 0.2% increase in same center sales in the patient care centers, and a $4.3 million increase principally related to sales from acquired entities. The $15.9 million increase in therapeutic solutions is primarily due to the acquisition of ACP on December 1, 2010.

 

Cost of Goods Sold - Materials.  Cost of goods sold - materials for the three months ended March 31, 2011 was $58.1 million, an increase of $4.4 million, or 8.3%, over $53.7 million for the three months ended March 31, 2010. The increase was the result of the growth in sales.  Cost of goods sold - materials

 

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as a percentage of net sales decreased to 29.0% in 2011 from 30.1% in 2010 due primarily to the lower cost of materials associated with the $15.9 million increase in sales at the therapeutic solutions segment.

 

Personnel Costs.  Personnel costs for the three months ended March 31, 2011 increased by $10.1 million to $78.9 million from $68.8 million for the three months ended March 31, 2010. The increase of $10.1 million from the prior year was due primarily to $8.2 million from acquired entities and the remainder of the increase results primarily from increased staffing and merit increases. As a percentage of net sales, personnel costs have increased by 80 basis points compared to the same period due to the acquired entities and to a lesser extent decreased leverage in our patient care centers as a result of staffing in anticipation of higher sales volumes in the second through fourth quarters of 2011.

 

Other Operating Expenses.  Other operating expenses for the three months ended March 31, 2011 increased by $2.1 million to $37.4 million from $35.3 million in the first quarter of 2010. The increase was due primarily to $3.3 million in acquired entities operating expenses offset by reductions in corporate overhead related to the relocation to Austin, Texas and a decrease in incentive compensation. Other operating expenses as a percentage of net revenues decreased 120 basis points to 18.7% from 19.9% in the first quarter of 2011 and 2010, respectively, due to continued focus on expense management.

 

Relocation Expenses.  We have substantially completed the relocation of our corporate office from Bethesda, Maryland to Austin, Texas. We continue to incur costs related to moving our employees due to the timing of selling homes and completing their permanent relocation. During the three months ended March 31, 2011, we incurred $0.4 million of employee relocation costs, as compared to $2.1 million incurred during the first quarter of 2010 which was comprised of $1.5 million of employee termination costs and $0.6 million of other relocation costs.

 

Depreciation and Amortization. Depreciation and amortization for the three months ended March 31, 2011 increased $3.0 million to $7.3 million compared to $4.3 million in the first quarter of 2010.  The increase is primarily due to $2.5 million related to acquired entities and $0.5 million related to operating assets purchased over the last 12 months.

 

Income from Operations.  Income from operations increased $4.2 million to $18.4 million for the three months ended March 31, 2011 compared to $14.2 million in the three months ended March 31, 2010. The current period experienced the combination of increased sales, lower operating expenses and lower relocation expenses.

 

Interest Expense.  Interest expense for the three months ended March 31, 2011 increased to $8.4 million compared to $7.5 million for the three months ended March 31, 2010 primarily due to increased debt levels resulting from our acquisition of ACP and the related refinancing in December of 2010, partially offset by lower interest rates.

 

Provision for Income Taxes.  The provision for income taxes for the three months ended March 31, 2011 was $3.8 million or 37.9% of pre-tax income, compared to $2.7 million or 40.0% of pre-tax income for the three months ended March 31, 2010. The effective tax rate consists principally of the federal statutory tax rate of 35.0% and state income taxes which were lower in 2011.  The tax provision for the three months ended March 31, 2011 benefited from approximately $0.1 million of discrete tax benefits and lower blended state tax rates compared to the same period in 2010.

 

Net Income.  Net income increased $2.2 million to $6.2 million for three months ended March 31, 2011 from $4.0 million for the three months ended March 31, 2010. The current period experienced the combination of increased sales, lower corporate office relocation expenses and a lower effective tax rate, as compared with the first quarter of 2010.

 

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Financial Condition, Liquidity, and Capital Resources

 

Cash Flows

 

Our working capital at March 31, 2011 was $194.1 million compared to $185.8 million at December 31, 2010. Cash flows used in operations of $11.5 million for the three months ended March 31, 2011 compared favorably to $12.1 million used in the prior year period, despite paying $4.8 million more in annual incentive compensation payments in the 2011 quarter. Days sales outstanding (“DSO”), which is the number of days between the billing for our O&P services and the date of our receipt of payment thereof for the three months ended March 31, 2011 increased to 47 days compared to 46 days for the same period last year.

 

Net cash used in investing activities was $10.4 million for the three months ended March 31, 2011 versus $9.1 million for the same period in the prior year. The increase was primarily due to increased investment in acquired businesses offset by lower capital expenditures in the first quarter of 2011 compared to 2010.

 

Net cash provided by financing activities was $5.2 million for the three months ended March 31, 2011 compared to cash provided by financing activities of $0.7 million for the three months ended March 31, 2010.  The 2011 cash provided by financing activities was higher than 2010 due to the $10.0 million borrowings under the revolving credit facility, offset by $4.1 million of additional financing cost incurred related to the amendment to our credit facilities completed in March 2011, and lower proceeds from employee related stock compensation plans.

 

Debt

 

Long-term debt consisted of the following:

 

 

 

March 31,

 

December 31,

 

(In thousands)

 

2011

 

2010

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

 

 

 

 

Revolving Credit Facility

 

$

10,000

 

$

 

Line of Credit

 

 

 

Term Loan

 

299,250

 

300,000

 

7 1/8% Senior Notes due 2018

 

200,000

 

200,000

 

Subordinated seller notes, non-collateralized, net of unamortized discount with principal and interest payable in either monthly, quarterly or annual installments at effective interest rates ranging from 3.00% to 7.00%, maturing through November 2018

 

8,970

 

8,684

 

 

 

518,220

 

508,684

 

Less current portion

 

(7,379

)

(7,006

)

 

 

$

510,841

 

$

501,678

 

 


(1)   At March 31, 2010, the Company had $175.0 million outstanding of 10 1/4% Senior Notes.

(2)   At March 31, 2010, the Company had $221.4 million outstanding on the Term Loan at 2.25%.

 

Refinancing and Amendment

 

During the fourth quarter of 2010, we refinanced our senior debt through the issuance of $200.0 million of 71/8% Senior Notes due 2018, a new $300.0 million Term Loan Facility which matures in 2016, and the establishment of a $100.0 million Revolving Credit Facility. We recorded a $14.0 million charge related to the early extinguishment of the senior debt, comprised primarily of $9.8 million of premiums paid to debt holders and a $4.2 million write-off of debt issuance costs and other fees. The proceeds of the refinancing were used for the following: (i) $184.8 million to retire the outstanding 101/4% Senior notes due 2014 and related premiums and fees; (ii) $220.3 million to retire the outstanding balance under the

 

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existing term loan facility; (iii) $16.9 million to pay debt issuance costs; and (iv) $78.2 million for general corporate purposes, including to partially fund the purchase price for the acquisition of ACP.

 

On March 11, 2011, we entered into an amendment to our Credit Agreement dated as of December 1, 2010. The amendment (i) reduced the interest rate margin applicable to the term loans under the Credit Agreement by 0.75% to 3.0% and (ii) reduced the LIBOR floor applicable to the term loans under the Credit Agreement from 1.50% to 1.0%. We incurred $4.1 million of fees related to the Amendment which will be amortized into interest expense over the remaining term of the debt.

 

Revolving Credit Facility

 

The $100.0 million Revolving Credit Facility matures on December 1, 2015 and bears interest at LIBOR plus 3.75%, or the applicable rate (as defined in the credit agreement), and includes a 1.50% LIBOR floor. The obligations under the Revolving Credit Facility are guaranteed by our subsidiaries and are secured by a first priority perfected interest in our subsidiaries’ shares, all of our assets, and all the assets of our subsidiaries. As of March 31, 2011 the stated interest rate is 5.25%.

 

The Revolving Credit Facility requires compliance with various covenants including but not limited to (i) minimum consolidated interest coverage ratio of 3.00:1.00 until September 30, 2011, 3.25:1.00 from October 1, 2011 to September 30, 2012, and 3.50:1.00 thereafter until maturity; (ii) maximum total leverage ratio of 5.00:1.00 until December 31, 2011, 4.50:1.00 from January 1, 2012 to September 30, 2012, and 4.00:1.00 from October 1, 2012 to September 30, 2013, and 3.75:1.00 thereafter until maturity; and (iii) maximum annual capital expenditures of 7.5% of consolidated net revenues of the preceding fiscal year with an additional maximum rollover of $15.0 million from the prior year’s allowance if not expended in the fiscal year for which it is permitted. At March 31, 2011, we were in compliance with these covenants. As of March 31, 2011, we have $86.6 million available under that facility. Availability under our Revolving Credit Facility as of March 31, 2011 was net of standby letters of credit of approximately $3.4 million and $10.0 million of outstanding borrowings. The $10.0 million draw was subsequently paid back in April 2011.

 

Line of Credit

 

On April 6, 2009, we obtained a collateralized line of credit from UBS in conjunction with the Rights agreement. The credit line was collateralized by our Indiana ARS and allowed us to borrow up to the fair market value of the ARS not to exceed its $5.0 million par value. We had drawn $3.6 million, which was the maximum allowed under the agreement. The credit line had no net cost to us as interest expense was equal to the income on the ARS. On July 1, 2010, we settled the $3.6 million line of credit with UBS in conjunction with settling the Rights agreement.

 

Term Loan Facility

 

The $300.0 million Term Loan Facility matures on December 1, 2016 and requires quarterly payments commencing March 31, 2011. From time to time, mandatory payments may be required as a result of capital stock issuances, additional debt incurrences, asset sales, or other events as defined in the credit agreement. The Term Loan Facility bears interest at LIBOR plus 3.0%, or applicable rate (as defined in the credit agreement), and includes a 1.0% LIBOR floor. At March 31, 2011, the interest rate on the Term Loan Facility was 4.00%. The obligations under the Term Loan Facility are guaranteed by our subsidiaries and are secured by a first priority perfected interest in our subsidiaries’ shares, all of our assets, and all the assets of our subsidiaries. The Term Loan Facility is subject to covenants that mirror those of the Revolving Credit Facility, and as of March 31, 2011, we were in compliance with these covenants.

 

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71/8% Senior Notes

 

Our 71/8% Senior Notes mature November 15, 2018 and are senior indebtness which is guaranteed on a senior unsecured basis by all of our current and future material domestic subsidiaries. Interest is payable semi-annually on May 15 and November 15 of each year, commencing May 15, 2011.

 

On or prior to November 15, 2013, we may redeem up to 35% of the aggregate principal amount of the notes at a redemption price of 107.125% of the principal amount thereof, plus accrued and unpaid interest and additional interest to the redemption date. On or after November 15, 2014, we may redeem all or from time to time a part of the notes upon not less than 30 not more than 60 days’ notice, for the twelve month period beginning on November 15, of the indicated years at (i) 103.563% during 2014; (ii) 101.781% during 2015; and (iii) 100.00% during 2016 and thereafter through November 15, 2018.

 

Subsidiary Guarantees

 

The Revolving and Term Loan Facility and the 71/8% Senior Notes are guaranteed by all of the Company’s subsidiaries. Separate condensed consolidating information is not included as the Company does not have independent assets or operations, the Guarantees are full and unconditional and joint and several and any subsidiaries of the Company other than the Guarantor Subsidiaries is minor. There are no restrictions on the ability of our subsidiaries to transfer cash to co-guarantors. All consolidated amounts in the Company’s financial statements are representative of the combined guarantors.

 

Debt Covenants

 

The terms of the Senior Notes, the Revolving Credit Facility, and the Term Loan Facility limit our ability to, among other things, incur additional indebtedness, create liens, pay dividends on or redeem capital stock, make certain investments, make restricted payments, make certain dispositions of assets, engage in transactions with affiliates, engage in certain business activities and engage in mergers, consolidations and certain sales of assets. At March 31, 2011, we were in compliance with all covenants under these debt agreements.

 

General

 

As of March 31, 2011, $309.3 million, or 59.7%, of our total debt of $518.2 million was subject to variable interest rates. We believe that, based on current levels of operations and anticipated growth, cash generated from operations, together with other available sources of liquidity, including borrowings available under the Revolving Credit Facility, will be sufficient for at least the next twelve months to fund anticipated capital expenditures, to fund our acquisition plans, and make required payments of principal and interest on our debt, including payments due on our outstanding debt.

 

Obligations and Commercial Commitments

 

The following table sets forth our contractual obligations and commercial commitments as of March 31, 2011 (unaudited):

 

Payments Due by Period

 

(In thousands)

 

Remainder of 2011

 

2012

 

2013

 

2014

 

2015

 

Thereafter

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Long-term debt

 

$

6,132

 

$

6,776

 

$

4,224

 

$

3,107

 

$

13,000

 

$

484,981

 

$

518,220

 

Interest payments on long-term debt

 

23,866

 

26,694

 

26,433

 

26,257

 

26,099

 

50,910

 

$

180,259

 

Operating leases

 

30,662

 

34,534

 

26,796

 

20,145

 

11,398

 

28,061

 

$

151,596

 

Capital leases and other long-term obligations (1)

 

7,684

 

7,801

 

6,213

 

3,685

 

1,584

 

11,971

 

$

38,938

 

Total contractual cash obligations

 

$

68,344

 

$

75,805

 

$

63,666

 

$

53,194

 

$

52,081

 

$

575,923

 

$

889,013

 

 


(1) Other long-term obligations consist primarily of amounts related to our Supplemental Executive Retirement Plan, contingent consideration payments and payments under the restructuring plans.

 

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The carrying value of our long-term debt, excluding the Senior Notes, approximates fair value based on rates currently available to the Company for debt with similar terms and remaining maturities. The fair value of the Senior Notes, at March 31, 2011, was $204.0 million, as compared to the carrying value of $200.0 million at that date. The fair values of the Senior Notes were based on the quoted market price of 102.0 obtained from Bank of America Merrill Lynch at March 31, 2011.

 

Off-Balance Sheet Arrangements

 

Our wholly-owned subsidiary, Innovative Neurotronics, Inc. (“IN, Inc.”), is party to a non-binding purchase agreement under which it purchases assembled WalkAide System kits.  As of March 31, 2011, IN, Inc. had outstanding purchase commitments of approximately $1.1 million that we expect to be fulfilled over the next three months.

 

Market Risk

 

We are exposed to the market risk that is associated with changes in interest rates.  At March 31, 2011, all our outstanding debt, with the exception of $309.3 million of the Term Loan and the borrowings under the Revolver, was subject to fixed interest rates (see Item 3 below).

 

Forward Looking Statements

 

This report contains forward-looking statements setting forth our beliefs or expectations relating to future revenues, contracts and operations, as well as the results of an internal investigation and certain legal proceedings. Actual results may differ materially from projected or expected results due to changes in the demand for our O&P products and services, uncertainties relating to the results of operations or recently acquired O&P patient-care centers, our ability to enter into and derive benefits from managed-care contracts, our ability to successfully attract and retain qualified O&P practitioners, federal laws governing the health-care industry, uncertainties inherent in incomplete investigations and legal proceedings, governmental policies affecting O&P operations and other risks and uncertainties generally affecting the health-care industry. Readers are cautioned not to put undue reliance on forward-looking statements.  Refer to risk factors disclosed in Part II, Item 1A of this filing as well as the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010 for discussion of risks and uncertainties. We disclaim any intent or obligation to publicly update these forward-looking statements, whether as a result of new information, future events or otherwise.

 

ITEM 3.                  Quantitative and Qualitative Disclosures about Market Risk

 

We have existing obligations relating to our 71/8% Senior Notes, Term Loan Facility, Revolver, and Subordinated Seller Notes. As of March 31, 2011, we had cash flow exposure to the changing interest rates on $309.3 million of the Term Loan Facility and borrowings under the Revolver. The other obligations have fixed interest rates.

 

Presented below is an analysis of our financial instruments as of March 31, 2011 that are sensitive to changes in interest rates. The table demonstrates the changes in estimated annual cash flow related to the outstanding balance under the Term Loan Facility and borrowings under the Revolver, calculated for an instantaneous parallel shift in interest rates, plus or minus 50 basis points (“BPS”), 100 BPS, and 150 BPS.

 

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Cash Flow Risk

 

Annual Interest Expense Given an Interest
Rate Decrease of X Basis Points

 

No Change
in Interest

 

Annual Interest Expense Given an
Interest Rate Increase of X Basis Points

 

(In thousands)

 

(150 BPS)

 

(100 BPS)

 

(50 BPS)

 

Rates

 

50 BPS

 

100 BPS

 

150 BPS

 

Term Loan

 

$

7,481

 

$

8,978

 

$

10,474

 

$

11,970

 

$

13,466

 

$

14,963

 

$

16,459

 

Borrowings under Revolver

 

$

251

 

$

301

 

$

351

 

$

401

 

$

451

 

$

501

 

$

551

 

 

 

$

7,732

 

$

9,279

 

$

10,825

 

$

12,371

 

$

13,917

 

$

15,464

 

$

17,010

 

 

ITEM 4.                  Controls and Procedures

 

Disclosure Controls and Procedures

 

The Company’s disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by it in its periodic reports filed with the Securities and Exchange Commission is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. Based on an evaluation of the Company’s disclosure controls and procedures conducted by the Company’s Chief Executive Officer and Chief Financial Officer, such officers concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2011 to ensure that information required to be disclosed in the reports filed under the Exchange Act was accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.

 

Change in Internal Control Over Financial Reporting

 

In accordance with Rule 13a-15(d) under the Securities Exchange Act of 1934, management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, determined that there was no change in the Company’s internal control over financial reporting that occurred during the three months ended March 31, 2011, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

Part II.  Other Information

 

ITEM 1A.  RISK FACTORS.

 

Part I, Item 1A (“Risk Factors”) of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 sets forth information relating to important risks and uncertainties that could materially adversely affect the Company’s business, financial condition or operating results. Those risk factors continue to be relevant to an understanding of the Company’s business, financial condition and operating results.  Certain of those risk factors have been updated in this Form 10-Q to provide updated information, as set forth below. References to “we,” “our” and “us” in these risk factors refer to the Company.

 

Changes in government reimbursement levels could adversely affect our net sales, cash flows and profitability.

 

We derived 40.4% and 40.6% of our net sales for the three months ended March 31, 2011 and 2010, respectively, from reimbursements for O&P services and products from programs administered by Medicare, Medicaid and the U.S. Department of Veterans Affairs. Each of these programs set maximum reimbursement levels for O&P services and products. If these agencies reduce reimbursement levels for O&P services and products in the future, our net sales could substantially decline. In addition, the percentage of our net sales derived from these sources may increase as the portion of the U.S. population over age 65 continues to grow, making us more vulnerable to maximum reimbursement level reductions by these organizations. Reduced government reimbursement levels could result in reduced private payor

 

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reimbursement levels because fee schedules of certain third-party payors are indexed to Medicare. Furthermore, the healthcare industry is experiencing a trend towards cost containment as government and other third-party payors seek to impose lower reimbursement rates and negotiate reduced contract rates with service providers. This trend could adversely affect our net sales. For example, a number of states are in the process of reviewing Medicaid reimbursement policies generally, including for prosthetic and orthotic devices, and Arizona has recently enacted legislation limiting Medicaid orthotic eligibility for those over 21 years of age. This legislation did not become effective until October 1, 2010, and we are evaluating its impact on our business in Arizona. Additionally, Medicare provides for reimbursement for O&P products and services based on prices set forth in fee schedules for ten regional service areas. Medicare prices are adjusted each year based on the Consumer Price Index—Urban (“CPIU”) unless Congress acts to change or eliminate the adjustment. The Medicare price (decreases)/increases for 2011, 2010, 2009, 2008 and 2007 were (0.1%), 0.0%, 5.0%, 2.7% and 4.3%, respectively. The Patient Protection and Affordable Care Act, Pub. L. No. 111-148, March 23, 2010 (“PPACA”) changed the Medicare inflation factors applicable to O&P (and other) suppliers. The annual updates for years subsequent to 2011 are based on the percentage increase in the CPI-U for the 12-month period ending with June of the previous year. Section 3401(m) of PPACA required that for 2011 and each subsequent year, the fee schedule update factor based on the CPI-U for the 12-month period ending with June of the previous year is to be adjusted by the annual economy-wide private nonfarm business multifactory productivity (“the MFP Adjustment”). The MFP Adjustment may result in that percentage increase being less than zero for a year, and may result in payment rates for a year being less than such payment rates for the preceding year. CMS has not yet issued a final rule implementing these adjustments for years beyond 2011, but has indicated in a proposed rule that it will do so as part of the annual program instructions to the O&P fee schedule updates. See 75 Fed. Reg. 40040, 40122, et seq. (July 13, 2010). If the U.S. Congress were to legislate additional modifications to the Medicare fee schedules, our net sales from Medicare and other payors could be adversely and materially affected.

 

We cannot predict whether any such modifications to the fee schedules will be enacted or what the final form of any modifications might be.

 

Our substantial indebtedness could impair our financial condition and our ability to fulfill our obligations under our indebtedness.

 

We have substantial debt. As of March 31, 2011, we had approximately $518.2 million of total indebtedness and $86.6 million available under our Revolving Credit Facility.

 

The level of our indebtedness could have important consequences to us. For example, our substantial indebtedness could:

 

·                  make it more difficult for us to satisfy our obligations;

 

·                  increase our vulnerability to adverse general economic and industry conditions;

 

·                  require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate requirements;

 

·                  limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

 

·                  place us at a competitive disadvantage compared to our competitors that have proportionately less debt;

 

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·                  make it more difficult for us to borrow money for working capital, capital expenditures, acquisitions or other purposes;

 

·                  limit our ability to refinance indebtedness, or the associated costs may increase; and

 

·                  expose us to the risk of increased interest rates with respect to that portion of our debt that has a variable rate of interest.

 

ITEM 6.                                              Exhibits

 

(a)           Exhibits.  The following exhibits are filed herewith:

 

Exhibit No.

 

Document

 

 

 

4.1

 

First Supplemental Indenture, dated December 13, 2010, by and among the Hanger Orthopedic Group, Inc., Accelerated Care Plus Corp., ACP Medical Supply Corporation, Liberty Health Services, LLC and Wilmington Trust Company, as trustee. (Filed herewith).

 

 

 

4.2

 

Second Supplemental Indenture, dated February 15, 2011, by and among the Hanger Orthopedic Group, Inc., Team Post-Op, Inc., a California corporation as the guaranteeing subsidiary, and Wilmington Trust Company, as trustee. (Filed herewith).

 

 

 

10.1

 

Amendment No. 1, dated as of March 11, 2011, to the Credit Agreement, dated as of December 1, 2010, among the Company and the lenders and agents party thereto. (Incorporated herein by reference to Exhibit 4.1 to the Current Report on Form 8-K filed by the Registrant on March 11, 2011).

 

 

 

31.1

 

Written Statement of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.2

 

Written Statement of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

32

 

Written Statement of the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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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.

 

 

 

HANGER ORTHOPEDIC GROUP, INC.

 

 

 

 

 

 

 

 

Dated:  May 4, 2011

 

 

/s/Thomas F. Kirk

 

 

 

Thomas F. Kirk

 

 

 

President and Chief Executive Officer

 

 

 

(Principal Executive Officer)

 

 

 

 

 

 

 

 

Dated:  May 4, 2011

 

 

/s/George E. McHenry

 

 

 

George E. McHenry

 

 

 

Executive Vice President and

 

 

 

Chief Financial Officer

 

 

 

(Principal Financial Officer)

 

 

 

 

 

 

 

 

Dated:  May 4, 2011

 

 

/s/Thomas C. Hofmeister

 

 

 

Thomas C. Hofmeister

 

 

 

Vice President of Finance

 

 

 

(Chief Accounting Officer)

 

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